Fund focus: DCL targets China's unremitting debtors

Will the economic fallout from COVID-19 create a new wave of non-performing loans (NPLs) in China as struggling companies fail to pay off their debts? For local private investors focusing on distressed assets – DCL Investments among them – it is a tantalizing possibility.

A sample study of 30 medium and large-sized banks recently conducted by the People’s Bank of China found that one-third would fail stress tests even under a mild impact scenario. The average NPL ratio of these lenders – which stood at 1.5% at the end of the first quarter – would surge to 4.9% in 2020, 5.5% in 2021 and 6.7% in 2022.

Conscious of vulnerabilities in the system, Chinese authorities are targeting NPL resolutions of RMB3.4 trillion ($520 billion) in 2020, compared with RMB2.3 trillion in 2019, according to Fitch Ratings. It estimates that credit costs for the banks it covers will increase to 1.9% of gross loans this year, up from 1.4% in 2019.

Against this backdrop, DCL has raised RMB3 billion for its latest renminbi-denominated fund. It has been nothing if not consistent in fund size. The firm’s two previous local currency vehicles closed in 2016 and 2017, respectively, also on RMB3 billion. A debut US dollar fund is also in the market – the target is $500 million and there has been a first close of sub-$100 million.

In addition to the market opportunity, DCL is looking to leverage a track record that reads 8% in annual cash distributions in each of the past four years. This year also saw Fund I realize 100% of its principal.

In the weeds

DCL regards strong on-the-ground capabilities across sourcing, management and exits as key to its success. Hualing Zheng, the firm’s chairman, describes his team as a “ground force” that collects and screens information and investigates related assets. They go in with a rough idea of likely sales volume for each financial institution and the nature of those assets, but the most important aspect of sourcing is strong relationships with suppliers.

“A stable transaction connection is the best form of partnership. Our transactions are very high frequency. We have invested RMB2-3 billion a year over the past five years, so we have established long-term relationships with all the suppliers in core areas that we focus on. Many overseas investors come to China to invest in special situations and they may do one large deal this year and then nothing the next year. It is difficult for them to form a stable connections with local suppliers,” says Zheng.

DCL has generated net cash returns of about RMB10 billion from its portfolio since inception, while deploying RMB11 billion. Consistent exit channels are also a function of strong relationships. The firm has cultivated a network of 700 potential buyers or partners who give regular feedback on market demand. “Often, when we buy an asset, we already know who we are going to sell it to, and at what price, which is why we collect cash fast,” Zheng adds.

The firm is also distinct from most foreign players in that it has developed an in-house team of asset servicers to handle post-investment management. With 10 people, this team is equal in size to the investment team.

Tony Dai, a managing director at DCL, claims this internal capability is instrumental when DCL makes decisions on exits as well as generating value from NPL portfolios on a continuous basis. “This is why we have record exits in 2018 and 2019 even as general domestic liquidity was at the low level and monetary policy was relatively tight,” he says.

Pyramid play

DCL articulates its strategy a pyramid comprising three parts: NPLs form the base, distressed real asset restructuring in the middle, and distressed corporate restructuring on the top.

“NPLs are the base because we are the largest private equity buyer. That’s where supply is also most stable. A NPL portfolio comprises anything between dozens and hundreds of loans. We select the best ones for real asset restructuring and corporate restructuring. The higher the tier, the harder it is, but there’s also less competition. By operating these underlying assets, we not only make money from a credit perspective, we also make it through asset value restoration,” says Dai.

DCL has a strong preference for NPLs tied to assets in China’s core economic regions, which include first-tier cities and areas such as the Yangtze River Delta and Pearl River Delta. The general objective is to buy cheap, identify potential champions buried in portfolios of dross, and help them maximize value.

One example is the Weibo Times Center in Beijing’s Zhongguancun district, which opened on schedule in March. The north building of tower C was placed as collateral for multiple loans that ended up in arrears. DCL bought the loans last year, assumed control of the property, completed the transfer procedures within one month, and began interior decoration. The was completed in December 2019.

Due to the fragmented nature of the property’s ownership prior to DCL’s arrival, rental levels had been falling for a long time relative to the surrounding area. Office space across the road in Beijing International Center, for example, was twice as much. With DCL’s support, a large internet company was secured as the sole tenant, paying a premium to the rent for the main building in tower C.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Fundraising
• Renminbi fund
• Credit/Special Situations
• China
• DCL Investments