Q&A: Shoreline Capital's Xiaolin Zhang

Q: Shoreline's third fund closed at $500 million in mid-2015 (and was followed by an overflow vehicle of $200 million). What does the speed and nature of deployment say about overall trends in the market?

A: We focus on three investment categories: structured finance, special situations and non-performing loans (NPLs). We have fully invested Fund III and the additional capital we raised, with approximately $700 million deployed over the last 12 months. Most of it went into NPL deals. We have accelerated our pace of deployment in response to the market opportunity. As China's economic growth has slowed in the last few years, the volume of NPLs accumulating within the banking system has been huge. The publicly disclosed NPL ratios of China's commercial banks doesn't tell you exactly how serious the situation is, because many more NPLs will emerge next year. Typically, they will involve struggling industries, such as mining companies in northwest China. Banks are under pressure to offload these bad loans.

Q: How easy is it to get access to NPL portfolios?

A: Shoreline is the largest player in the NPL and distressed market in China apart from the big four asset management corporations (AMCs). In the previous cycle, we were the most active investor in the NPL space so we have cultivated close relationships with banks and AMCs. Some banks contact us directly and arrange transactions that are nominally routed through AMCs. We have more than 40 employees, most of whom came from the AMCs, banks or law firms. In addition, we are growing our network of local third-party service providers from 50 to 100. This nationwide platform will help us source NPL transactions.

Q: What do you think of the government initiatives intended to help address the NPL problem, such as debt-for-equity swaps?

A: The debt-for-equity swap initiative shows the government is looking for solutions, and Shoreline can benefit in that it can extend our business lines. There are potentially high-quality companies in financial difficulty that we can restructure after swapping their loans for equity. However, a professional team with deep legal knowledge is necessary to properly evaluate and execute debt-for-equity swaps. We have plenty of experience handling such legal issues but we would still invite industry experts and external partners to work with us on deals.

Q: What complications are there for US dollar-denominated investors chasing NPL deals? Do you also have renminbi-denominated pools of capital?

A: It was hard for us to operate in this space when we invested our debut US dollar fund. But we have built a strong deal-sourcing and investment platform over the last 12 years, which has made things a lot easier. More recently, Issues such as repatriation of capital and renminbi depreciation have become concerns for US dollar investors, but we believe these are temporary and there are financial tools that can be used to mitigate the impact. As for local currency transactions, we have participated in some.

Q: How much competition does Shoreline face?

A: We are still the leading player in China's distressed debt space, but I have seen more newcomers on the US dollar side and the renminbi side in the last year. We can't expect to be the only large player as the market matures. A number of international investors have expressed an interest in investing in this space. I don't see them as competitors but rather as potential partners because Shoreline has a level of localization they cannot match. On the US dollar side, we have previously partnered with Oaktree Capital on some co-investments. On the renminbi side, several local service providers have tried to raise independent funds but they are small. We will commit capital to their funds and jointly invest in deals.

Q: How do you manage these portfolios once they have been acquired?

A: Before we buy NPLs, we conduct thorough due diligence on the borrowers, guarantors and registered collateral in order to set a meaningful purchase price. If the collateral is factory facilities, for example, we have to evaluate how much we can generate if we liquidate those assets in the future. We have built a database that tracks land supply and turnover rates in different provinces and cities, which helps us to price the underlying assets. In terms of collecting debts, we negotiate terms with the borrowers or go through court processes to liquidate the collateral assets. Another option is to convert these debts into equity and run a company yourself. There are many ways to collect repayment; the key point is whether you can generate a profit by doing this.

Q: Shoreline has seen some team turnover, including the departure of co-founder Ben Fanger. How have you addressed these issues?

A: As a result of Ben's departure, six other people have left Shoreline, and they are all bound by a two-year non-compete clause. The biggest loss was to our investor relations function - four people left from that team, while we have lost only two from the investment team. We are in the process of rebuilding our LP relationships and we are actively looking for an investor relations partner to lead that function.

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• Topics
• Greater China
• Credit/Special Situations
• Restructuring
• Restructuring
• GPs
• China
• Distress
• Shoreline Capital Management