Why China hasn’t seen more defaults

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http://www.cnbc.com/id/101858389

Why China hasn’t seen more defaults
Leslie Shaffer | Writer for CNBC.com
37 Mins Ago
CNBC.com
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Despite starting the year with dire predictions that China faced a slew of defaults, few mainland borrowers have welshed on their debts, thanks to various stripes of government intervention.

"The central government earlier this year issued a decree saying [local governments] need to focus on preventing financial or regional systemic risk," Donna Kwok, senior China economist at UBS, told CNBC. "Local governments have taken this to heart," stepping up intervention either by directly or indirectly bailing companies out or actively mediating between corporates and banks, Kwok said.

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China's debt levels – which soared to 250 percent of gross domestic product (GDP) according to some estimates – have been a major concern for investors for years, spurring fears that the surge in borrowing is fueling a dangerous property bubble and overcapacity in many industries, including steel, mining and solar energy, any of which could face collapse as the economy slows and Beijing tries to choke off overinvestment.

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Concerns spiked anew after little known Huatong Road & Bridge Group Co. warned last week it wouldn't be able to pay down its debt, likely marking the first time a Chinese company is set to openly default on both principal and interest for a bond.

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Reuters reported late Wednesday that sources directly involved said Huatong Road's aggressive fund raising, combined with funds contributed by local government bodies in Shanxi province may have enabled the company to avoid a default.
In addition to managing the bond market, the government is also looking to keep the shadow banking sector, which accounts for around a quarter to a third of total credit, on an even keel, Kwok noted.

"They've been trying for the last few months to re-intermediate some of the credit away from the shadow banking system back to formal bank loans, which arguably is in a much more solid and firmer state," she said.

Others cite the mainland's recent easing of credit conditions are helping to support the bond market, but risks still remain.

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"The outlook over the coming months is unusually uncertain" for credit policy, especially amid signs that Chinese bond issuers are becoming more sensitive to credit access, Morgan Stanley said a note last week on China's bond market.

"Compared to their global peers, Chinese corporates are more leveraged, more short-term funded and typically generate negative free cash flow," it noted. The bulk of debt for many Chinese high-yield issuers, which are riskier by definition, is still made up of short-term bank loans, it said.

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In addition, easing credit isn't floating all borrowers' boats, it noted.

"Even as credit conditions improve, they still appear to be benefitting larger, higher-rated credits far more than smaller, lower-rated peers," Morgan Stanley said. "China is increasingly a two-tier credit market."

Banks, which directly or indirectly fund more than 80 percent of China's total credit, have been exercising pricing power, with 70 percent of the loans in the first quarter extended at above-benchmark rates and as much as 25 percent priced above 8.5 percent yield, it noted.
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To be sure, UBS's Kwok also noted that just because things have been relatively quiet on the default front doesn't mean the risk has gone away.

Others expect more defaults ahead.

"More credit risk events are looming in China's overleveraged economy, and some may be related to the ongoing property correction," Nomura said in a note last week.

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House prices on the mainland increased at double-digit rates throughout most of 2013, but began cooling toward year-end as government tightening measures started to take effect.

"The property market correction reduces developers' demand for land, but also strains the fiscal finances of the heavily indebted local governments that rely on land sales to finance their budgets," Nomura said. "That said, the situation is delicate, and the balance of risks is skewed to the downside," Nomura said.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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China protests highlight shadow lending problems

DOW JONES AUGUST 15, 2014 11:45AM

A wave of small protests outside banks and government offices around China in recent days has cast a spotlight on shadow lending, a sector that provides important alternative financing channels for small firms shut out of regular bank loans.

On Tuesday, a group of investors in the city of Chengdu in Sichuan province held a demonstration in front of local government buildings after one of the biggest credit-guarantee companies in Sichuan failed to step in and cover loans to small firms it had insured.

A day earlier, a few dozen investors staged protests outside Industrial & Commercial Bank of China branches in Guangzhou and Shanghai after they had been told they would need to wait at least another 15 months to get the payout on a trust-company product sold at the bank that they wanted the lender to step in to ensure payment.

Protesters carried a banner reading, "Swindler ICBC, pay back our blood-and-sweat money," outside an ICBC branch in Guangzhou. The product's prospectus didn't mention any liability for ICBC in case of default, but several investors said the bank had assured them of the product's low risks.

Neither ICBC nor the trust company responded to requests for comment.

Regulators have long sought to curb the proliferation of shadow lending on concerns of a buildup of debt. A widely anticipated wave of defaults among China's trust companies--which act as conduits by raising money to invest in assets or to make loans--has so far failed to materialize. But the protests, which follow other similar events around China in recent months, serve as a reminder of the difficulty to pin down who is responsible when something goes wrong.

The Sichuan protests illustrate the problematic role of lightly regulated credit-guarantee companies, which have become an important component on the path to loans for China's small and medium-size firms. Bank and other financial institutions typically require significant collateral, which small firms rarely have, to back a loan. But they are sometimes willing to extend credit if another company promises to pay off the loan if the borrower can't. The credit-guarantee companies give banks and other lenders peace of mind that their loans are safe, charging the borrower a small fee for the service.

An investor surnamed Gao in Chengdu said he invested 500,000 yuan ($80,600) in a small loan company late last year, with the funds then being lent out to small businesses in the province. Mr. Gao said he was promised at least 15% annualized return on his investment.

The lending was guaranteed by Huitong Credit & Guaranty Co., which said in a statement on July 15 that its chairman and other executives hadn't been seen for more than a week. Phones rang unanswered at both the company and local government offices on Thursday.

"I learned from local press that the executives [of Huitong] have run away and then I knew my investment was in danger," said Mr. Gao.

Besides small loan companies, Huitong also guaranteed loans to small firms made by trust companies and banks. It isn't clear whether those investments are also at risk.

The unclear role of banks in the sale of trust-company instruments is at the heart of the ICBC protests. The product that sparked the protests was issued by China Credit Trust Co. and attracted a total of 1.3 billion yuan ($210 million) from investors. It had required a minimum investment of at least three million yuan and promised around 10% annualized return.

The company said it would pay back investors over the coming 15 months, after selling its collateral, including several coal mines.

"ICBC managers told us the product was safe and both the principal and interests are guaranteed," said Zhang Liang, an investor in Guangzhou who attended Monday's protest. "If it wasn't sold by ICBC, we would not have bought the product since we never heard of this trust firm before," he said.