China’s capital markets and lending environment are characterized by inefficiencies from both economic growing pains and government policy shifts. The result is twofold: Many well-run Chinese companies cannot obtain sufficient capital to finance growth; this produces high yield opportunities for structured asset-backed financings. Conversely, often some companies get funding not because of the health of their balance sheets, but for other non-credit related reasons such as government economic policy directive. This results in non-performing loans (NPLs) and distressed asset sales.
The distressed investment opportunity in China began with recapitalization of China’s banks in the late 1990s when hundreds of billions of non-performing loans (NPLs) surfaced after decades of substandard credit risk management. Beijing took the “bad bank” approach to remove the NPLs from banks’ balance sheets and set up four “asset management corporations” to dispose of them. Years later, there is still a substantial chunk of the NPLs waiting to be resolved.
The China distressed opportunity ballooned after the global financial crisis in 2008. China reacted with an unprecedented stimulus package that forced banks to open a floodgate of lending. The easy credit era started again, sending banking reforms to the backburner. Although Chinese regulatory agencies have stated that the risk control quality in Chinese banks has improved considerably in recent years, few people dispute that there will be a substantial amount of NPLs as a result of this lending spree.
As the fear of asset bubbles crept up in real estate, the Chinese government responded by taking several cooling measures in early 2010, including cutting lending to developers regardless their credit worthiness or demand for their projects. This led to a surge in massive demand for high-yield structured special situation financing for well-run corporations or projects.
As long as China experiences growing pains from its rapid economic transformation, and as long as China’s monetary policies are not perfectly tailored to the market, capital allocation inefficiencies will continue to exist. The misallocation of capital and the related distress in China are among Shoreline Capital’s primary sources of opportunity.