Chinese companies are increasingly stepping in as lenders, as banks reduce their funding to struggling industries and the country’s mammoth bond market comes under strain.
Company-to-company loans in China jumped by 20 per cent last year to 13.2 trillion yuan ($2.5 trillion), according to research firm CEIC. That is roughly double the size of the loan book at Wells Fargo, the biggest lender in the US. This entrusted lending, so named because banks serve as middlemen, is now the fastest-growing major component of the country’s elaborate system of informal, or shadow, banking.
The most recent surge came during the sell-off in China’s $US9.3 trillion ($12.2 trillion) bond market late last year. Big, cash-rich companies — mostly state-owned enterprises and some private companies — stepped in: new entrusted loans rose to 405.7 billion yuan in December, more than double the month prior, according to data tracker Wind Information, and the highest monthly issuance in two years.
But the practice poses broader risks for China’s economy.
Instead of investing in their core business, companies can earn interest rates of up to 20 per cent making entrusted loans, often with only cursory checks on borrowers’ creditworthiness. Such lending often props up companies in sectors like mining and property where Beijing wants to reduce excess capacity. It also adds to China’s $US18 trillion corporate debt pile, already equal to 168 per cent of gross domestic product, according to the Bank for International Settlements.
Some entrusted loans are between a company and its own subsidiaries, similar to how many big companies globally loan cash to different parts of their businesses. Still, between 2007 and 2013 more than 60 per cent of entrusted loans were channelled to companies in industries with overcapacity, according to a study by the US-based National Bureau of Economic Research.
“It’s not a sustainable business model” for the lending companies, said Julian Evans-Pritchard, China economist at Capital Economics. “Their main operations are only staying afloat by acting like a shadow bank.”
Aluminium Corp of China, or Chalco, is one major company where lending has become a big business. With its main smelting operations struggling due to a glut of aluminium, the company has ramped up its lending to boost profits. Chalco, a publicly traded unit of state-owned Chinalco, took in 30.7 million yuan in interest income from entrusted loans in the first six months of 2016 — more than four times as much as a year earlier and nearly 50 per cent of its net profit. In a texted response to a request for comment, Chalco said the increase in entrusted lending was part of an effort to centralise capital management and employ assets flexibly while lowering funding costs.
Company-to-company lending took off in China in the 1990s when, after a period of rapid growth, many state-owned firms started generating large amounts of cash. With no private shareholders pushing for dividend payouts, many put that cash to work by lending it out.
But entrusted lending is unusual. Banks are involved, but only as the middleman: direct company-to-company lending is still legally prohibited. Banks can charge fees of up to 5 per cent of the loan, according to BMI Research, but leave credit checks to the lending company. “When a bank lends, they have to do their homework, they have experienced credit analysts,” said Warut Promboon, chief ratings officer at Chinese firm Dagong Global Credit Rating. Mr Promboon added that in his experience, few Chinese companies had the personnel to adequately assess credit risks.
In some cases, lending companies do not pull back even when loans sour. In June, Datang International Power Generation Co, a state-owned energy company, said it would write off $US8bn of its $US10bn portfolio of entrusted loans made a year earlier to small coal companies in which it owned stakes.
“If our subsidiaries suffer more, it will make it more difficult for them to get bank loans,” said a Datang International representative. “In this case, we may issue more entrusted loans.”
Entrusted lending can provide a last-ditch option for companies black-listed from other funding avenues. Chinese banks aren’t allowed to extend normal loans to companies in default.
In December, China Cinda Asset Management Co agreed to provide Shandong Shanshui Cement Group with an entrusted loan of up to 8 billion yuan. The loan’s terms weren’t disclosed
Shanshui, one of China’s biggest cement makers, had defaulted on nearly 12 billion yuan of its debt as of June 2016, according to disclosures. A slump in China’s cement industry drove defaults and bondholder lawsuits.
Companies sometimes charge sky-high rates for loans to risky industries. Zhejiang Longsheng Group, a privately owned chemicals producer whose customers include Nike and Wal-Mart Stores, is charging 17 per cent interest — four times China’s one-year benchmark lending rate — for a one-year, 250 million yuan loan to Zhejiang Time Square Trading Co.
Wall Street Journal