Saturday, 24 December 2011

China local debts dwarf ambitions

Provinces go deeper into the red to finish projects - from the Manhattan to highways to a stadium fronted by Olympic rings

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Guanyu said...

China local debts dwarf ambitions

Provinces go deeper into the red to finish projects - from the Manhattan to highways to a stadium fronted by Olympic rings

Bloomberg
22 December 2011

A copy of Manhattan, complete with Rockefeller and Lincoln centres and what passes for the Hudson River, is under construction an hour’s train ride from Beijing. And like New York City in the 1970s, it may need a bailout.

Debt accumulated by companies financing local governments such as Tianjin, home to the New York lookalike project, is rising, a survey of Chinese-language bond prospectuses issued this year indicates. It also suggests the total owed by all such entities likely dwarfs the count by China’s national auditor and figures disclosed by banks.

Bloomberg News tallied the debt disclosed by all 231 local government financing companies that sold bonds, notes or commercial paper through Dec 10 this year. The total amounted to 3.96 trillion yuan (S$816 billion), mostly in bank loans, more than the current size of the European bailout fund.

There are 6,576 of such entities across China, according to a June count by the National Audit Office, which put their total debt at 4.97 trillion yuan. That means the 231 borrowers studied by Bloomberg have alone amassed more than three-quarters of the overall debt.

The fact so few of the companies have accumulated that much debt suggests a bigger problem, says Fraser Howie, the Singapore-based managing director of CLSA Asia-Pacific Markets who has written two books on China’s financial system.

‘You should be more worried than you think,’ he said of Bloomberg’s findings. ‘Certainly more worried than the banks will tell you.

‘You know how this story ends - badly,’ he said.

The findings suggest China is failing to curb borrowing that one central bank official has said will slow growth in the world’s second-largest economy if not controlled. With prices dropping in China’s real estate market, economists warn that local authorities won’t be able to repay their debt because of poor cash flow and falling revenue from land sales they rely on for much of their income.

Provinces and cities are going deeper into the red to finish projects, from the Manhattan on the east coast, to highways in north-western Gansu and a stadium fronted by Olympic rings in Hunan, central China. Many were started as part of China’s stimulus programme to beat the 2009 world recession. The financing companies accounted for almost half of the 10.7 trillion yuan in all local government debt tallied by the official audit.

The 231 borrowers whose public filings were reviewed by Bloomberg raised a combined 354.1 billion yuan by selling securities this year. They have credit lines from banks of at least 2.3 trillion yuan that have yet to be drawn down, the documents show.

Bank lending continues to rise, Bloomberg found, even after China’s banking regulator repeatedly warned banks to control risks associated with it and speed up repayment.

Forty-seven of the 56 local financing companies that issued prospectuses from Oct 1 through Dec 10 said their debt load had increased this year. The combined debt of those issuers rose 10 per cent from the end of 2010.

What’s more, adding up lending by bank also raises the question as to whether China’s lenders are understating their exposure to local government debt. Only 113 of the local government borrowers disclosed such a breakdown; and yet this small group appears to account for an outsized portion of what the banks have said is their overall lending.

Guanyu said...

Lines of credit

For example, China Construction Bank Corp, the world’s second-biggest bank by market value, has lending to those 113 local government borrowers of 250 billion yuan. That’s 43 per cent of the 580 billion yuan the bank said it had extended in loans to all such borrowers at the end of June.

The bank has untapped lines of credit to the vehicles of a further 341 billion yuan.

Disparities like this suggest lenders may have bigger risks than they’ve disclosed publicly, says Charlene Chu, a banking analyst at Fitch Ratings Ltd in Beijing.

China Construction Bank said it stood by its total for loans to local governments and that cash flow from them was ‘good’. Non-performing loans to such companies amounted to 6.5 billion yuan, or 1.11 per cent of the total, and the lender had set aside provisions of more than three times that, it added.

The prospectuses offer a rare window into borrowing by the local government financing vehicles. The issuers disclose total debt and often details of their loans and lines of credit from banks and trust companies. The data are not consistent, with some reporting total debt as at the end of 2009 and some as recently as Sept 30 this year.

Local authorities, who shoulder most of the infrastructure spending in China, have to keep borrowing to complete projects so they can generate cash flow needed to start paying debt back, said Vincent Chan, head of China research at Credit Suisse Group AG in Hong Kong.

Yao Wei, an economist at Societe Generale SA in Hong Kong, says another seven trillion yuan of debt will be needed to finish projects in the government’s five-year plan through 2015.

‘At some point the central government will realise this is too big to complete,’ said Ms Yao. Banks will need to be recapitalised as bad loan rates rise, she said. At least 1.4 trillion yuan of soured debt was taken off banks’ books after China’s last lending crisis which began in 1998.

Senior Chinese banking officials themselves have been raising alarm bells. Xie Duo, director-general of financial markets at the People’s Bank of China, told a Nov 23 Beijing conference that local governments depend too heavily on bank borrowing and failure to solve the problem will hurt economic growth. China’s banking regulator in November asked lenders to control the risks associated with the vehicles and said that slumping land sales mean some projects may run out of funding.

Loans to local government companies aren’t a problem because the projects will generate returns, even if not immediately, said Huang Jifa, deputy general manager for investment banking at Industrial & Commercial Bank of China Ltd (ICBC), the country’s biggest lender.

‘The money that Chinese local governments have borrowed is not like the money people borrowed in Europe or Greece,’ Mr Huang said in a Nov 24 interview. ‘The Chinese government’s borrowed money is all invested. Many projects will have returns.’

The bank says it had extended 931 billion yuan of such loans as at June 30. Outstanding local government financing vehicle-loans at the end of the third quarter declined from the first half, an ICBC spokesman said. He wouldn’t comment further.

A building boom by thousands of local governments became the backbone of the country’s stimulus programme started in November 2008 - on borrowed money. The financing companies were created starting in the 1990s and enabled provinces, cities, counties and townships to bypass rules barring most of them from directly selling bonds.

Projects undertaken include a stadium, which resembles Beijing’s iconic Bird’s Nest Olympic venue, in Jinan, the capital of eastern China’s Shandong province; and a superhighway in the country’s second-poorest province of Yunnan that stretches into the foothills of the Himalayas, where there are no cities of more than one million people.

Guanyu said...

In Tianjin, about 160km south-east of Beijing, a sea of hundreds of construction cranes stretches along both sides of the river at an oxbow that gives the Yujiapu financial district its Manhattan-like shape, testimony to the scale of China’s ambitions. Downriver are the ruins of centuries-old forts stormed by British and French troops during the Second Opium War in 1860.

To build Yujiapu, Tianjin officials are piling onto borrowing that is already at least almost half a trillion yuan - equivalent to half the annual per capita income of the city’s 13 million people. More than 5,000 people were moved out of the area starting in 2008 to make way for the project, among the millions nationwide evicted from homes to make way for China’s urbanisation projects.

The planned 15.2 million sq m of office space by 2020 in Yujiapu and across the Hai River in Xiangluo Wan, or Conch Bay, is more than one-third of the 450 million square feet in Manhattan.

One of the companies building Yujiapu - Tianjin Binhai New Area Construction & Investment Group Co - sold 10 billion yuan in bonds in November. It earmarked one billion yuan from the sale to fund the construction of the district’s transport hub, which includes a high-speed rail line that will cut the time to Beijing to 45 minutes. In the first half of the year its debt, mostly from banks, rose 11.9 per cent from the end of 2010 to 71 billion yuan, according to the prospectus.

More borrowing is needed, Tianjin Vice-Mayor Cui Jindu said on Sept 16. New loans to the city’s financing vehicles may slump by as much as 140 billion yuan in 2011 from last year’s level as lenders curb risks and boost support to small and medium-sized businesses, he said.

‘If the banks don’t give us any new loans, there will be problems,’ Mr Cui said, saying some projects in the city may not get completed. Tianjin had ‘no problem’ repaying loans this year, having to that date paid off 33 billion yuan of the 39.5 billion yuan in principal due this year, he said. Another 60 billion yuan is due in 2012, Mr Cui added. Some 14 of 122 planned buildings are under construction in Yujiapu, as are all 48 skyscrapers in Conch Bay, said Xu Fei, vice-chairwoman of the office of the Tianjin Binhai New Area CBD Commission, as she stood in front of a brightly lit model of the future city.

Rising debt

They include a 588-m-high tower, taller than the 541-m-high 1 World Trade Center currently under construction in the real Manhattan, being built with the help of the Rockefeller family’s Rose Rock Group. Steven Rockefeller Jr attended a Dec 16 groundbreaking event for the project, which includes the skyscraper inspired by the Rockefeller Center in New York, Zhao Jia, an outside spokeswoman for Rose Rock, said. The Lincoln Center is advising on the construction of a performing arts centre. Yujiapu’s resemblance to the Big Apple extends to its rising debt that analysts such as Mr Howie say is unsustainable. New York was near bankruptcy in 1975 after a succession of overspending administrations, before then-president Gerald Ford agreed to lend it US$2.3 billion.

‘In many of these projects, like the mini-Manhattan, it’s never going to make money,’ Mr Howie said. ‘Maybe the government can write a check from somewhere else. But that means education gets affected, health gets affected. There’s a cost somewhere else, because they’re wasting all these resources.’

Tianjin Infrastructure Construction and Investment Group Co, another state-owned builder working on Yujiapu, is the most heavily indebted local government financing vehicle in China to disclose its finances in bond prospectuses this year with 291 billion yuan in debt. It sold three billion yuan of bonds in April.

An official with Tianjin’s foreign affairs office said no one was available to answer questions about whether the city’s financing vehicles had sufficient cash flow to service their debts.

Guanyu said...

The true level of local government debt nationwide is hard to ascertain because the borrowing vehicles are mostly opaque. There’s even disagreement over how many exist. The People’s Bank of China, the country’s central bank, said in a June 1 report there were more than 10,000.

In a separate study, China’s banking regulator tallied 9,828 as of the end at November 2010, according to an unpublished report cited by the 21st Century Business Herald in March.

‘It’s very likely that senior government leaders have no way of knowing which numbers provide the best picture of the evolving lending binge China’s banks seem to be on,’ said Carl Walter, who retired as chief operating officer in China for JPMorgan Chase & Co earlier this year and is co-author with Mr Howie of Red Capitalism, an analysis of China’s banking system.

The audit office said that it counted debt that local governments have responsibility to repay, that they have guaranteed, or other debts that they may be liable for. People’s Bank of China didn’t answer faxed questions. An official with the China Banking Regulatory Commission said to use the audit office’s figures.

The number of loans going bad will rise because of the borrowers’ poor cash flow, according to a November report from London-based HSBC plc. Around 68 per cent of 184 local financing companies that have sold bonds analysed by HSBC had a return on capital lower than 5 per cent, the benchmark lending rate last year, compared with 37 per cent for all 499 corporate issuers it studied, the report said.

‘One of the problems with the local government financing vehicle loans issued in 2009 was there was a mismatch between the duration of the assets and the duration of the liabilities,’ said Michael Werner, a banking analyst at Sanford C. Bernstein & Co in Hong Kong. ‘If you’re building a railroad or a highway, it takes several years and you’re not going to get direct revenues.’

Take Gansu Provincial Highway Aviation Tourism Investment Group Co. The company builds roads across the arid province, including a 3.4 billion yuan, 235km stretch of high-speed expressway along the ancient Silk Road to Jiayuguan, at the westernmost pass of the Great Wall of China.

Cash flow

Its total debt surged 29 per cent in the first nine months to 15 per cent of the province’s gross domestic product last year. The company’s entire 2010 operational cash flow was 3.04 billion yuan, while it had 55.9 billion yuan in bank borrowing reported at the end of September. The revenue wouldn’t cover interest payments at China’s standard lending rate of 6.56 per cent, let alone paying down principal.

Fortunately for Gansu Highway, it doesn’t have to roll over interest. Almost half of its outstanding loan principal and interest due this year - 24.1 billion yuan - is being rolled over into its outstanding bank debt, and the company plans to repeat that exercise every year until at least 2019 when it is forecast to owe lenders 148.9 billion yuan, according to a chart in the prospectus it issued for a 2 billion-yuan bond sale last month.

Gansu Highway’s situation encapsulates the problem of local government borrowers, which often have minimal or no plans to repay debt aside from borrowing more money, says Fitch’s Ms Chu. ‘In the past, Chinese banks could carry borrowers like this indefinitely,’ she said. ‘But today they don’t have the large cash reserves they used to to do this. I don’t see how all of this doesn’t turn into a major problem at some point.’

Lei Wanming, the deputy Communist Party secretary for the Lanzhou- based company, said Gansu Highway had no problem covering interest and principal payments.

‘You can’t look at look at Gansu roads just from an economic perspective,’ he said, citing the benefits they will bring to poorer regions and its role in helping to eventually connect China and Europe with high-speed expressways.