Entrusted loans can be an opaque state of affairs in China
Lack of information means it is hard to assess the viability of the increasing number of loans being made to government-related entities
Much has been said about the risk of an entrusted loan. Yet, when a listed firm enters into one, the information available to its shareholders is close to nothing. The case of Shandong Chenming Paper Holdings illustrates this. Early this year, the papermaker announced making an entrusted loan.
As in most of the 11 entrusted loans announced since January 2012 totalling HK$5.5 billion, the announcement provided only the most basic information - the size of the loan, the borrower's name, the maturity, the interest rate, and the pledge. All the shareholders know is that Chenming lent 1 billion yuan (HK$1.25 billion) to Shouguang Jin Choi Public Assets Management for two years at an interest rate of 10 per cent.
The only means to assess the risk is the designation "entrusted loan". Crucial information such as the financial condition of the borrower and details of the pledge is nowhere to be found. In most cases this is very much the end of a journalist's research. Fortunately, Chenming is lending to a very special entity - the fundraising platform of a domestic government.
An internet search showed Jin Choi is an infrastructure and property developer owned by the Shouguang city government, which is also the single largest shareholder of Chenming. In short, the manufacturing arm of the county government is lending to its developing and financing arm.
(This does not count as a connected transaction because Chenming and Jin Choi are owned by different entities controlled by the government.)
For years, Chenming has been working hard to reduce its gearing ratio, which stood at about 68 per cent - not a very comfortable level for a manufacturer. Then why did it make the loan? Let's not jump to the conclusion that Chenming has been ordered or arm-twisted into the deal. Let's look at the fundamentals.
Chenming pointed to the pledge of Jin Choi's 20 per cent stake, which it said is valued at 1.8 billion yuan. The company did not name the base of the valuation. Neither is there any independent appraisal.
(That is not too bad when compared to the disclosure in most entrusted loans. In some cases, the pledge can be as blank as "a piece of land" or "two residential units in Beijing".)
The reality, however, is much less comfortable, according to Jin Choi's 2013 annual report.
To be fair, Jin Choi has managed to get an AA rating from a mainland agency with a 45.5 per cent asset-liability ratio. Yet, its 17.5 billion yuan assets include 3.5 billion yuan of receivables due from the government. Although a significant amount has expired, Jin Choi sees no need to make any provision because "it is owned by the government".
With the huge receivables, Jin Choi has been experiencing a negative cash flow for three consecutive years, amounting to 499 million yuan last year. It is running on a debt of 7.7 billion yuan.
That liability does not reflect the 2.4 billion loan guarantee it has provided for local firms such as hospitals, restaurants, petrochemical companies and property developers.
All these numbers may not sound too alarming. But Shouguang is only a county-level city in Shandong with a population of 1.1 million and an annual fiscal income of 14.5 billion yuan.
Nevertheless, Jin Choi managed to raise 2.2 billion yuan at 6.2 per cent interest by issuing corporate bonds in 2010 and 2012. That is when Beijing decided to allow local governments some breathing space amidst a tightening in land sales.
Liquidity gets increasingly tight and the city government turned to the trust loan market. That has become difficult. The yearly growth of infrastructure-related trust products has slowed from 104 per cent in 2012 to 20 per cent last year. With 168 billion yuan of these products due this year, the growth in the past six months slowed further.
The city government's fundraising was hit as well.
The government's financial arm, supported by the guarantee of Jin Choi, paid 9.2 per cent for a two-year loan of only 20 million yuan last month. A similar product for 152 million yuan cost it only 8.5 per cent in November last year.
The latest trust loan is managed by Zhongrong Trust, which is seen as the most aggressive in the industry. In the city's scramble for cash, Chenming's 1 billion yuan loan is a great relief. The big question is why should a listed firm do it?