China's hidden debt stirs angst
Rising defaults in China are unearthing hidden debt at companies across the country.
Small firms that can’t get loans by themselves have been winning banks over by getting other companies to guarantee their borrowings. The companies making those pledges exclude them from their balance sheets, leaving creditors in the dark. Borrowers often extend the guarantees for each other, raising the risk that failures could ricochet, at a time when increasing borrowing costs have already added to strains.
China’s banking regulator has ordered checks of such cross-guaranteed loans, Caixin reported on Friday. Scrutiny is mounting after a corn oil producer in the eastern province of Shandong said last month it had guaranteed debt of a neighbouring aluminium product manufacturer which is now stuck in a cash crunch. Just days before that, a local government financing vehicle in China’s southwest had to repay an auto parts maker’s loans it had guaranteed after the latter defaulted.
“Disclosure of such guarantees isn’t timely,” said Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co. “Sometimes, it’s like a buried mine and you don’t know when the risks will explode.”
This debt minefield could be big. The amount of loan guarantees at privately held firms in China is equivalent to 11 per cent of their equity, and at LGFVs is 18 per cent, according to Citic Securities Co. The load is even heavier at weaker borrowers. About 44 per cent of issuers rated lower than AA- have a ratio of more than 30 per cent, according to Everbright Securities Co. The phenomenon is less common in the US because banks don’t require such guarantees to offer loans, according Fitch Ratings.
“A guaranteed company may be guarantor for another company which guarantees another one,” said Wang Ying, head of China research initiative at Fitch in Shanghai, who said bond issuers should at least release guarantee numbers on a quarterly basis. “The worst scenario is a chain reaction.”
Investors dumped corporate bonds issued by borrowers in Zouping County in Shandong after the corn oil producer, Xiwang Group, said on March 29 that it has 2.9 billion yuan ($US421 million) of outstanding guarantees, the equivalent of 17 per cent of equity, for debts of Qixing Group Co.
Two calls to Xiwang’s general office were not answered.
Guarantors don’t mark the pledges on their balance sheets and often disclose them only on an annual basis. Such shadow debts pose rising risks after central bank tightening pushed up onshore corporate bond yields to two-year highs and defaults on local notes surged to a record.
As China opens up the world’s third-biggest bond market, the hidden debt also presents a challenge for international investors grappling with what bond legend Bill Gross dubbed the “mystery meat of emerging-market countries”. Moody’s Investors Service received more inquiries from global investors about such guarantees following the incident in Zouping, according to Ivan Chung, head of Greater China credit research.
“The cross debt guarantees definitely raise concerns,” said Ivy Thung, head of credit research in Singapore at Nikko Asset Management Asia. “Disclosure is definitely not in a timely manner and generally companies will not talk about this unless asked.”
Contagion, systemic risk
China Chengxin International Credit Rating sometimes has to resort to sources other than the company in question to obtain guarantee data.
“When we’ve done on-site due diligence on some rated firms, it was hard to get comprehensive and reliable information about their external guarantees,” said Kong Lingqiang, Beijing-based vice president at China Chengxin. The central bank should allow rating assessors access to the national financial credit system to get the latest information about companies’ pledges for loans, Kong said.
China Bond Rating said guarantors should disclose guarantees in quarterly reports and also release information about the firms for which they provide the biggest pledges.
“Cross guarantees for unrelated companies could lead to contagion and even systemic risk,” said Xia Le, Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria. “Since the central bank has started tightening, more hidden cross guarantees may emerge.”
The pledges sparked a crisis in the eastern province of Zhejiang in 2012 during a monetary tightening cycle, prompting 600 companies to ask for the provincial government’s help, according to 21st Century Business Herald at the time.
“In China, this practice has stemmed from a structural deficiency of the banking system: since private companies have difficulties accessing credits from banks, they need to boost their financial profile by forming complex webs of relationship-based cross guarantees,” said Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group. “The toxin will surface when the monetary condition starts to tighten.”