August 13, 2014
Interviewed by: David Snow
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Deal Story: Profiting from a Bad Loan in China

Benjamin Fanger of Shoreline Capital describes an investment in which his firm purchased a troubled loan and ended up victorious in a Chinese court.

Benjamin Fanger of Shoreline Capital describes an investment in which his firm purchased a troubled loan and ended up victorious in a Chinese court.

Deal Story: Making Money on a Bad Loan in China

Private Capital in China

David Snow, Privcap: We’re joined today by Rob Petty of Clearwater Capital Partners, Ben Fanger of Shoreline Capital, and Bob Partridge of EY. Gentlemen, welcome to Privcap. Thanks for being here.

All of you are experts at private investing in Asia, especially in China, so it’s great to have you here. It’s one thing to talk in general terms about what’s going on in the China private equity market, but I’d love to hear some stories that exemplify the state of play in China and also real stories from your actual investment activities.

Ben Fanger, Shoreline: Sure. Certainly our style of investment doesn’t exemplify private equity generally in China, and we’re distressed investors, but it’s relevant at a time like now—when deceleration is occurring, banks are recognizing and selling on performing loans, and so forth—to talk about these types of things. One question that constantly comes up among investors and other people is, “What is the legal system like in China and can you enforce credit in China?” An example of a deal we did was we bought a portfolio of hundreds of nonperforming loans, corporate loans. One of these was a loan to a state-owned enterprise that was no longer operating and didn’t have any assets we could find. Obviously, you price it at basically zero and then it’s in this pool of nonperforming loans that you purchase.

Snow: Sorry. Did you purchase it from a bank?

Fanger: From a bad bank—one of the AMCs. This SOE borrower also had a guarantor and the guarantor also was not operating but—

Bob Partridge, EY: Also a state-owned enterprise?

Fanger: Also a state-owned enterprise, which you can sue in China, just like you can sue a privately owned company. But we found evidence that they had transferred all their assets to a subsidiary of an extremely large tobacco company in China. When we found that out, we employed what’s called “fraudulent conveyance” law or claim to say, “You got all the assets but you didn’t take the liabilities; now you also have to take on the liability.”

What’s interesting was that whereas 10 years ago, when we started Shoreline, maybe you could only sue the borrower and guarantor, China’s legal system is developing to a point where you can actually sue other people who you would be able to sue in a western court—the transferee of assets for lack of consideration.

Another interesting element of that case was that that subsidiary was one of the largest taxpayers in the province, so obviously there’s local protectionism. Beijing has a rule that you can transfer to Beijing if there’s any chance of local protectionism, which we did. We ended up freezing their bank accounts, their land, and some equity holdings they had in other companies. Then, they’re coming to the table wanting to pay us to go away. The goal of that legal process is to get to a point where you have enough leverage to get them to settle.

Rob Petty, Clearwater:  Similar to the U.S.

Fanger: Similar to the U.S., yes. Though, as I said before, you might only be able to do four things with predictability in China, whereas in the U.S. you can do 10 things with predictability, if you’re relying on those four things and pricing them in. That’s why we buy things at less than 10 cents on the dollar, mostly. Then, you can still navigate the legal system in China and actually have it work.

Petty: A couple of interesting things in this case (and we have similar ones, although not as deeply experienced in some of the distress things). One, the court has evolved so that you can see evolution in it not just because western players are in here, but because this is important for the Chinese lenders and the development of the court system around that. That point is really worth saying. There is real evolution and it’s not because of foreigners.

Fanger: It’s not because we wanted it to happen.

Petty: Exactly. So, saying that. Then the second point is, you could actually get good outcomes and you sometimes want to hear war stories and it’s a bad outcome. It’s not always the case that you can get good outcome.

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