Chinese Firms Fill Lending Gap

BEIJING—Cash-rich Chinese companies ranging from electronics manufacturers to shipbuilders are making big bets on a potentially lucrative business: lending money to other, less-flush companies.

But that emerging profit center is becoming a hindrance for some of the lenders, as scrutiny increases on an expanding but murky corner of China's shadow banking system.

Yangzijiang Shipbuilding (Holdings) Ltd., a Singapore-traded Chinese shipbuilder, earned a third of its total income through the third quarter from investment products and lending to small businesses, a category that was up 65% from a year earlier.
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But the company has been defending its loan business in recent weeks in light of a number of bankruptcies of small manufacturers who failed to repay private loans. Yangzijiang did not make the loans but was forced to release a statement in October saying it "does not foresee potential negative impact on its financial performance." It declined to comment further. Its shares are down 53% this year compared with a 14% drop in Singapore's main benchmark.

"Entrusted" loans, as this type of company-to-company debt is called, increased by 562.5 billion yuan ($87.9 billion) from a year earlier, to 1.07 trillion yuan in the first three quarters, according to the most recent data from the People's Bank of China.

The jump came even as China's total social financing, a broad measure of credit, shrank 1.26 trillion yuan, to 9.8 trillion yuan, over the same period largely due to a drop in bank loans amid Beijing's tightened monetary policy.

In an analysis for The Wall Street Journal, ChinaScope Financial, a Hong Kong-based research firm partly owned by Moody's Corp., found that from July to November, 38 listed Chinese companies disclosed 52 new issues of entrusted loans, totaling 6.2 billion yuan. Interest rates on these loans reached as high as 24.5%.

The concern among some analysts is what happens if the economy falters and borrowers are unable to repay. The loans "may invoke higher-than-expected default risk, as the strength of the borrowers tends to be relatively low," according to David Cui, China strategist at Bank of America Corp.'s Merrill Lynch unit.

Market watchers worry that loans made to property companies in particular could have a broader impact on the economy, as many are thinly collateralized with land and could default as the property market cools.

Sunny Loan Top, an electronics manufacturer in east China's Zhejiang province, disclosed in July that it had extended for six months three loans it made to contractors and developers that came due in March, totaling 110 million yuan ($17.3 million). The company didn't respond to requests for comment.

Its shares this year are down 26% year to date, compared with a 16% drop in Shanghai's main stock index.

Lending outside formal bank channels—called shadow finance or shadow banking in China—has led to concerns about a potential increase in bad debt in China's financial system as its economic growth slows. Estimates vary because the lending is largely unregulated, ranging from 12 trillion yuan ($1.9 trillion) to 20 trillion yuan ($3.2 trillion), or between 30% and 50% of China's gross domestic product. Shadow finance includes entrusted loans and other types of loans such as those extended in the black market by loan sharks.

While large companies continue to obtain bank loans, small manufacturers who account for a big part of the economy have to turn to alternative sources for financing.

Meantime, corporations flush with cash have been eager to find uses for their money other than have it sitting in banks. The one-year benchmark deposit rate is 3.5%, while the rate of inflation is 5.5%.

In its analysis for the Journal, ChinaScope found that the companies that have extended entrusted loans have underperformed broader Chinese markets in Shanghai and Shenzhen, though it isn't clear whether entrusted loans are the reason in each case. Still, investors have become skeptical of them.

"The entrusted loans from public companies show that these companies have a large amount of cash in their hands but might use the money in detriment of shareholders' interest," said Zhu Chaoping, ChinaScope's head of research.

Yangzijiang Shipbuilding is based in southern China's Jiangsu province. Previously state-owned, it was restructured as a private company in the late 1990s. Its chairman, Ren Yuanlin, is considered one of China's richest men and has won accolades from analysts and investors for having led the company through the global financial crisis with a solid performance and strong balance sheet.

However, Yangzijiang, which makes a range of commercial vessels, also has seen its stock drop in recent months partly because of the company's exposure to informal lending.

As of September, such financial assets totaled 10.4 billion yuan, or about 33% of the company's total assets, it said, more than double the level at the end of 2009.

Yangzijiang also owns a small-loan company and has a 31.5% equity stake in another. These "microfinance" lenders often charge interest rates up to four times the benchmark rate. In a presentation accompanying its earnings announcement, the company said its investments in these two lenders, totaling 394.5 million yuan, were "purely opportunistic" and could make "potential huge profits."

Source: http://online.wsj.com/article/SB10001424052970203413304577084273003740712.html?mod=WSJAsia_hpp_LEFTTopStories