Introduction:The domestic distressed asset investment market has attracted increasing attention from global institutions. Selina ZHENG, chairman of DCL, accepted an exclusive interview with Preqin on the dynamics and opportunities of the market when DCL Special Situation RMB Fund IV is about to complete its first close.

By Marissa Lee from Preqin

International money managers are increasingly warming up to the opportunity in Greater China-focused private debt, which includes direct lending, mezzanine financing, distressed, and special situations strategies. 

We spoke with Selina Zheng, President of distressed assets specialist DCL Investments, about the dynamic private debt landscape in China.

1. What notable developments have you seen in the Greater China private debt/special situations market in recent years?

Selina Zheng: More sellers are seeking to dispose of distressed credit assets as a result of the COVID-19 pandemic, so the types of distressed assets and products have gradually become diversified. We believe that the next few years will continue to be a good window for non-performing asset investments. 

First, the NPL ratio of commercial banks has continued to reach new highs over the past 10 years, and banks face regulatory pressure to step up efforts to write off NPLs. 
Second, the number and size of projects financed by China’s trust industry that are deemed to carry a degree of risk has hit a new high in recent years. Trust funds are more actively seeking external partners for the restructuring or direct transfer of risky projects, many of which involve high-quality assets. 
Finally, the slowdown in economic growth has led to a deterioration in the overall credit environment, and a large number of private enterprises are unable to repay their own debts due to liquidity issues. 
In 2020, in response to the pandemic, a series of short-term hedging policies were introduced at the supervisory level, and default risks were delayed. We believe that the supply of distressed assets will continue to show up and increase in the next few quarters.

2. Where do you see the best opportunities for private debt in China right now?

Selina Zheng: From a deal-sourcing perspective, brokerage firms, trust companies, and other non-bank financial institutions have become more and more important sources of distressed asset opportunities in recent years, alongside traditional banks and asset management companies.

From a geographical point of view, the Yangtze River Delta, the Pearl River Delta, and Beijing are areas that we particularly like, because of high asset quality, efficient and transparent law enforcement, and sufficient liquidity for transactions.

3. How would you describe the current fundraising environment for Greater China-focused private debt?

Selina Zheng: We have seen more and more institutional investors participate in special situations investments as LPs. DCL closed the Special Situation RMB Fund III in October 2020, with a total fund size of $450mn. The fund’s LPs include banks, insurers, investment arms of brokerage firms, state-owned enterprises, FOFs, endowments, and others.

DCL Special Situation RMB Fund IV is expected to complete its first close in April this year, and we are seeing growing interest from all kinds of LPs.

Although 2020 was a tough year for most GPs in the RMB market to raise significant money from LPs, GPs with competitive advantages and specialized expertise fared better in terms of fundraising. Moreover, top-tier GPs in each asset class are still attracting most of the capital, and we believe this trend will continue for a while. 

4. There are now more channels and opportunities for foreign credit funds to make investments in China. Do you see international GPs increasing their activity in the Chinese private debt market now?

Selina Zheng: At present, competition for distressed assets in China is still dominated by local investment institutions. Due to the impact of COVID-19, among other reasons, foreign institutions are currently less active in China. Going forward, we strongly believe that local players have a significant advantage in both deal sourcing and exits. In fact, local presence is one of the key attributes of successful distressed asset investors across the globe.

5. What is your expected target return, and how do you hope to achieve this?

Selina Zheng: For NPLs and single-loan assets, on a deal level, we expect a 18-20% gross IRR, mainly through debt transfers, litigation recovery, borrower settlement, etc. – among which we expect a higher return for single-loan deals.

For distressed asset-based special situations deals, we generally expect a gross IRR above 20%, and the exit strategies we pursue are mainly loan-to-own, bankruptcy reorganization, repayment of debts, and exit after restructuring.

The title has been adjusted by DCL.
The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin and the firm(s) providing the information in this content accept no liability for any decisions taken in relation to the above.