China Developer’s 20% Loan After Bank Rebuff Signals Risk

China Developer’s 20% Loan After Bank Rebuff Signals Risk

China property developer Zhang Fuguo was rejected by banks for a loan to help keep building two office towers in the central city of Zhengzhou. So he turned to a manufacturer of water and gas meters. The 50 million yuan ($8.2 million) loan last month at a 20 percent interest rate will help Zhang pay workers and buy materials and was like “delivering coal on a snowy day,” he said. It was less so for one board member at lender Henan Suntront Technology Co. (300259), who abstained from approval on concern that Zhang’s company would fail to repay the debt. So-called entrusted loans, in which banks are “entrusted” with funds as middlemen between companies, increasingly grease the wheels of China’s economy, withstanding a crackdown on shadow banking this year and rising to a record 293.8 billion yuan in August. The increase was part of a surge in non-bank credit that may add to default risks threatening Premier Li Keqiang’s efforts to sustain 7 percent expansion this decade.“The more that we have financial activity taking place in the shadow-banking system, under the current regulatory standards and regime, the more risky that it is,” said Louis Kuijs, chief China economist at Royal Bank of Scotland Group Plc in Hong Kong.

Entrusted loans and other financing outside the main banking system are “not so well regulated,” and “people who hold the assets don’t always understand and don’t always know where the money is actually being used,” said Kuijs, who previously was a World Bank economist in Beijing.

Record Streak

The increase in aggregate financing followed an unprecedented four straight month-on-month declines and the government’s signal that it would defend the year’s 7.5 percent expansion goal after two quarterly slowdowns.

Li, who’s preparing for a Communist Party meeting in November on economic-policy reforms, said Sept. 11 that the nation is taking steps to stabilize expansion and can achieve the main economic targets this year.

Shadow lending, which allows banks to bypass controls and capital requirements, may be valued at 36 trillion yuan, or 69 percent of gross domestic product, JPMorgan Chase & Co. estimated in May.

The entrusted loans in August were equivalent to 41 percent of the month’s 711.3 billion yuan in new local-currency bank loans. That’s the second-highest percentage in the past five years.

Both types of lending are part of aggregate financing, the government’s broadest measure of credit, which almost doubled to 1.57 trillion yuan last month from July, People’s Bank of China data showed.

Cash Crunch

Regulators, in an effort to clamp down on speculative lending after a record credit boom in the first quarter, allowed a cash crunch in June that sent money-market interest rates to record highs. It had little effect on entrusted loans, which accounted for about 24 percent of total credit in July, the highest proportion since 2007, before dipping to 19 percent in August.

“In the short term it is positive for growth,” said Dong Tao, head of economics for Asia excluding Japan at Credit Suisse Group AG in Hong Kong. “However, compared with bank loans it has less transparency and bigger risks. It is a blind spot of regulation.”

Tao said the August pickup in credit shows that “quietly, shadow-banking channels opened again” as the government softened its regulatory stance.

Boost Supervision

The government says debt risks are manageable. Vice Finance Minister Zhu Guangyao said earlier this month at a Group of 20 nations summit in St. Petersburg, Russia, that while China should strengthen supervision of shadow banking, officials are aware that smaller businesses need access to finance.

RBS’s Kuijs said the increase in credit will probably prove temporary because key people such as the premier “are telling us that they do not want to go in that direction.”

Lenders include Ningbo Yunsheng (Group) Co. (600366), a magnet maker, and Shanghai Tunnel Engineering Co., a local government’s infrastructure-construction arm. At least 110 publicly-traded companies announced plans to lend about 20 billion yuan to other firms in the first half, charging annual interest rates ranging from 7 percent to 12 percent, according to Shanghai Wusetu Mortgage Service Co.

Zhu Haibin, chief China economist at JPMorgan in Hong Kong, said entrusted loans reflect demand from companies to support operations, and one month’s increase “may not be a big problem.”

Imperial Seal

The complex being built by Zhang, the developer in Zhengzhou, is called Yuxi, or Imperial Seal. On Sept. 13, sounds of drilling and hammering of construction machinery emanated from the site as two yellow cranes carried materials.

Billboards enclosing the two unfinished concrete towers of about 16 and 25 stories advertised the property as the “heart of a city, vibrant metropolis,” as cars and buses inched forward in rush-hour traffic around the site.

Suntront, the meter maker, said in a July 31 filing with the Shenzhen Stock Exchange that the one-year loan to Zhang’s company, Henan Fuguo Property Co., will improve the manufacturer’s returns and won’t harm corporate or shareholder interests. “The entrusted loan has sufficient guarantees from buildings under construction as collateral,” Suntront said.

Li Shuqu, the Suntront director who abstained from approving the loan, cited Henan Fuguo’s liability-to-asset ratio of about 65 percent, net assets of 78.4 million yuan, losses and lack of revenue, according to Suntront.

Zhang said in a telephone interview that banks had turned down his loan application because of restrictions on lending to property developers.

“Money will flow in once sales officially start,” he said. “With the loan, I am fully confident about the financial prospects.”

–Zhou Xin, Shen Hu, with assistance from William Bi in Zhengzhou, China, and Luo Jun in Shanghai. Editors: Scott Lanman, Sunil Jagtiani

To contact Bloomberg News staff for this story: Zhou Xin in Beijing at xzhou68@bloomberg.net Shen Hu in Beijing at hshen33@bloomberg.net

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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