A big source of easy financing for Chinese companies is coming under pressure, leaving in its wake a string of corporate defaults.
Starting in 2015, China’s asset management industry became a booming centre for “shadow finance”, lending outside the formal banking sector. Banks, securities houses and trust companies were able to raise cash from wealthy investors and structure lending products through accounts at asset management companies. Loans linked to asset management companies, and structured finance products called asset management plans became hugely popular.
By the end of March, securities companies had Rmb1.99tn ($280bn) in funds linked to asset managers that had been lent out through such arrangements, according to the Asset Management Association of China.
Meanwhile, global asset managers have been allocating more money than ever to Chinese stocks and fixed-income products.
But after several years of abundant credit and easy refinancing, the environment has changed.
Recognising a build-up in lightly regulated, high-risk lending that was occurring in the industry, the government cracked down on asset management lending last year. That, along with an overall tightening in credit starting in 2018, has forced many companies to default on the structured loans.
“At the peak time, when the asset management companies developed the fastest due to the high liquidity of the market, they invested a lot of money in high-risk companies,” said Ivan Chung, an associate managing director at Moody’s.
“Now it has become a vicious circle,” said Mr Chung. “The weaker corporates do not have enough cash flow to repay their debts, leading to their capital chains being broken, and to these defaults.”
Most defaults on such products do not require public disclosure because they are not publicly traded securities. However, in several severe cases, such as a Rmb2bn default at Lianchu Securities earlier this year, investors have become vocal about mounting losses. Some have taken to social media to complain.
Groups such as property developer Zhonghong Zhuoye have defaulted on multiple loans from different securities houses and trust companies. Zhonghong, which once owned a controlling stake in SeaWorld Entertainment, used such borrowings to buy assets overseas but has since been forced to sell off those businesses.
“This was [China’s] attempt at structured finance but it has backfired,” said a Beijing-based investment banker familiar with the financing structure.
Defaults on the complex products are expected to continue this year and could intensify if money market rates rise, experts warn.
One popular version of the product allowed a company to buy its own bond through an account with an asset management company and then use that account as collateral for short-term loans in the interbank market, effectively repurposing the original bond into a repo market loan.
The arrangement worked well when there was ample liquidity in China’s money markets. However, the tightening of rates over the past year, followed by rises in interbank rates in May and June, have made many of the bonds far too expensive to refinance, leading to defaults.
“These asset management plans have to refinance constantly through the short-term repo market, which can make them vulnerable,” said Cindy Huang, a senior director at S&P Global Ratings. “One of the problems we see is that when these plans fail to refinance in the repo market, some of them may default.”
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