Debt distress in Shandong province illustrates risks of interlocked credit guarantees
A financing crisis that broke out among a group of private firms in Shandong province in eastern China, which involve several mainland- and Hong Kong-listed companies, appears to have calmed as the company at the centre of the quarrel repaid its outstanding debt and interest on Friday.
But investors involved in the interlocked credit guarantee group remain cautious as the information disclosed is limited, casting a shadow on the stock and bond products offered by companies based in the region.
The crisis broke out among a group of private firms, making it less contagious than if state-owned companies had been involved. But it still highlighted how China’s interlocked credit market is exposed to a high risk within a struggling private sector and the precarious health of some banks.
At the centre of the financing circle was Qixing Group, whose management had now effectively been taken over by Xiwang Group under the direct instruction of the local government in Zouping county, Xinhua reported.
On Wednesday, Qixing was reported to have defaulted on a bank repayment worth up to seven billion yuan (US$1 billion), causing a plunge in the shares of Xiwang Foodstuffs, the Shenzhen-listed arm of Xiwang Group.
Investors were selling their shares in Xiwang Foodstuffs in a panic because its parent is the biggest guarantee provider for Qixing. In the event that Qixing were to fail, Xiwang would potentially be on the hook for 2.9 billion yuan in outstanding debt.
During the next three months, Xiwang would have to make advance interest payments on Qixing’s debt and inject more than one billion yuan of capital to help restore its normal operations, the China Securities Journal reported on Wednesday.
“So far, a crucial issue is whether Xiwang has the obligation to take ultimate responsibility for the debt problem at Qixing,” said Ivan Chung, an analyst with ratings agency Moody’s Investors Service.
It may be hard for Xiwang to turn down the arrangement by the county government, but the tricky issue is how to separate the obligation to support local companies from its listed businesses.
“If the group company is dragged down, it will definitely have an impact over its listed entities, but information disclosure is not transparent enough for investors to make an estimate,” Chung said.
In addition to Xiwang Foodstuffs, Xiwang Group also controls Xiwang Steel and Xiwang Property Holdings, both listed in Hong Kong.
Another important issue was the size of the cross-guarantee web, Chung said.
Local media group Shandong Business News reported that more than 10 billion yuan worth of loans were extended to Qixing and several other local companies, which provided guarantees for each other.
When contacted by the South China Morning Post, a Qixing representative declined to provide details on the matter, saying the “people in charge” were not available.
Meanwhile, investors are dumping the bonds issued by China Hongqiao Group and Weiqiao Textile, two other listed companies based in Zouping.
It is not known if these two firms are involved in the credit chain. Short-selling institution Emerson Analytics earlier issued a report claiming Hongqiao inflated its profit, sparking a sell-off in the stock.
“Our investigations and analysis have shown that, mainly through underreported costs and ‘subsidies’ provided by connected parties disguised as independent third parties, Hongqiao has fabricated the profitability that vastly exceeds those of its peers,” Emerson Analytics said in the report issued on February 28.
The two companies have requested permission from the Hong Kong bourse to delay publication of their annual reports.
Hongqiao, the world’s largest aluminium smelter, is also applying for duty exemption to avoid a US$700 million offshore loan default clause.
The situation is a replay of the 2012 debt crisis in Wenzhou, China’s richest economic hub, which caused hundreds of private companies to go bankrupt and billions of yuan in bad debt for banks, said Chen Shujin, an analyst with Huatai Financial Holdings (Hong Kong).
Access to capital remains a challenge for private businesses as the country’s state-owned banks prefer to lend to state-owned firms, which are implicitly underwritten by the government.
In a bid to get bank loans, private companies sometimes form into groups to leverage on each other’s credit. But this also means taking on failure risk. In the event that one company fails to meet a loan repayment, banks can force the guarantors to repay the debt of its peer.
“If the latter fails to repay, usually banks would suspend new lending. That could be fatal to private companies that rely heavily on bank loans for operation,” Chen said.
Some Chinese banks tend to favour cross-guarantees as the risk of a group default is smaller than that of an individual.
“But what happened to Wenzhou had already proved this is not always the case,” Chen said.
Chung also said cross-guarantees worked fine only when the economy was going upwards.
“But when it is going downwards while accompanied by tightened credit policies, they are likely to trigger chain reactions,” he added.
Another issue is whether banks have become overextended.
“Banks tend to lend more to listed companies and their guaranteed entities, but the recent crisis shows the risk is high,” Chen said.
Hong Kong-listed China Huishan Dairy Holdings, which operates in Liaoning province in the northeast, saw its shares plummet 85 per cent on March 24, a day after its executive team held an emergency meeting to discuss a capital crunch to repay 11 billion yuan in debt.
The company’s treasury head has since gone missing while four other directors have resigned. Controlling shareholder Yang Kai declared he had sold part of his 87 million yuan stake in the company on the day of the share plunge, without saying whether the disposal was forced.