Bad loan shuffle: How Chinese state companies make debts disappear

Deal involving Shandong-controlled entities highlights complexity of such maneuvers

Shandong International Trust is a non-bank financial company under the provincial government in Shandong, China.    © Getty Images

KENJI KAWASE, Nikkei Asia chief business news correspondentApril 19, 2023 17:30 JST

 

HONG KONG -- The chairman of China's Shandong International Trust was happy to talk about how the state-owned company weathered the tough economic climate of last year.

Speaking at SDITC's annual earnings briefing last week, Wan Zhong pointed to a 25% year-on-year increase in assets under management and a 27% surge in pretax profit to 591.23 million yuan ($86 million), among other bright spots.

What he and other executives did not mention in their presentations were the complicated transactions with another local government-controlled entity that allowed SDITC to neatly offset a 2.5 billion yuan loss incurred from the disposal of nonperforming assets.

Such maneuvering, experts say, is common across China and serves to obscure the extent to which bad debt is piling up in the country's financial system.

In the case of SDITC, two trusts holding nonperforming loans were sold to Shandong Financial Asset Management (SFAM), a provincial-level asset management company (AMC). Both SDITC and SFAM have the same parent -- Shandong Lucion Investment Holdings Group -- which is in turn controlled by the Shandong provincial government.

SDITC was the trustee of both funds and the sole lender of the loan portion of their portfolios.

Shandong International Trust's Chairman Wan Zhong, center, said a string of transactions between state-level companies were "extremely normal" at its annual earnings briefing in Hong Kong on April 12. (Photo by Kenji Kawase)

The first trust, Ruiyuan 61, was established in April 2017, and had loan principal plus interest totaling 5.49 billion yuan. The property assets under this trust include about 10,000 square meters of housing property and more than 80,000 square meters of land use rights, both in Beijing. The trust also held a 100% equity interest in the borrower, an unspecified Chinese real estate developer that defaulted on the loan in March and April of 2020.

The latter, Ruiyuan 76, was set up in February 2018 and had principal and interest totaling 2.58 billion yuan. Its property assets include housing and related land-use rights in Suzhou and Beijing, plus 100% equity interest in two companies controlled by the borrower.

The key assets of those two companies are described as the "players and franchise of a football club" and "a stadium located in [China] which is currently under renovation." The companies defaulted on their loans in December 2019 and February 2021.

The trusts were put up for public auction on a local Shandong trading platform, but the only entity to express interest in either one was SFAM, the company with which SDITC shares a parent.

The 2.5 billion yuan loss on the sale, moreover, was almost perfectly canceled out by a related transaction. In a deal bundled with Ruiyuan 76, SDITC sold its entire 16.675% stake in Fullgoal Fund Management, one of China's oldest and the largest fund managers, to SFAM. SDITC made 2.67 billion yuan on this sale.

Following these transactions, SDITC sold its entire 1.36% stake in SFAM to their parent, Lucion, in a deal that was completed in February.

Chairman Wan of SDITC -- who doubles as vice general manager of Lucion -- described the string of deals among the Shandong state entities as "extremely normal corporate activity" when he was asked about the transactions. He did not directly address a question about the profit from the Fullgoal stake sale so closely matching the losses.

All the deals, he said, were conducted via an "open" platform, and an affiliate ended up being the buyer only because "companies with certain connections have more confidence and understanding of our assets."

The three companies directly involved in the series of deals are ultimately controlled by the finance bureau of the Shandong provincial government, which in turn is under the supervision of the Communist Party Committee of the province.

Disclosures that appear to be related to the transactions are no longer available on the website of the Hong Kong Exchange, where SDITC is listed. Three documents -- two from Dec. 13 and one from June 29 -- titled "major and connected transaction" and "very substantial disposal and connected transaction" are listed on the site, but clicking on the links gives the following message: "The document that you are looking for has been removed by the listed issuer and is no longer available."

SDITC said that it has the right to delete certain documents after 14 days under the listing rules and that it is a "usual practice by Hong Kong-listed companies" to do so. The Hong Kong Exchange told Nikkei Asia it does not comment on individual companies.

A Hong Kong-based corporate governance expert, however, speaking under condition of anonymity, said, "It's not a usual practice to delete documents on the exchange's official website."

It is rather common for an unlisted local asset management company to emerge as a buyer of nonperforming loans in China, but this has its risks.

Sherry Zhao, senior director of international public finance at Fitch Ratings, told Nikkei Asia that current trends suggest the policy role of local asset management companies has been "strengthened by involving [them] in resolving local property issues." But doing so "is likely to increase their credit profile vulnerability [and] could accelerate the polarization of credit quality of local AMCs."

She adds that "their capital strength depends on the ability and incentive of local governments to [provide] support."

Fraser Howie, market analyst and co-author of "Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise," told Nikkei Asia that such transactions are another example of "kicking the can down the road."

"The seemingly unfailing growth and lack of financial crisis in China is due to poor assets being swapped and hidden away in vehicles of which we know nothing except they have some sort of state backing," he said. Such backing does not mean these entities will treat bad assets properly, he added, but "it does mean that many questions aren't asked" due to a lack of accountability and transparency.

"This process has been going on for decades right across the state sector, but we have now reached the point that China has less and less capacity to absorb such activity" as growth decelerates in the country, Howie said. "The short-term appearance is that things are fine, but what is really happening is the economy is being ever more clogged with zombie companies and assets."

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