Why is the guarantee market in such a state of disorder? The financial “earthquake” caused by a default by Hebei Financing Investment Holding Group will have an enduring legacy. Li Shangjing reports.
The impact of the default crisis at Hebei Financing Investment Holding Group (HFIHG) is still reverberating. In has been reported recently that several senior managers of the group were placed under investigation by the regulator, pointing to a bigger crisis for the company – which is already struggling to cope with long lines of debtors outside its doors. The default occurred because the company provided excessive guarantees in violation of rules in exchange for business expansion. The incident turned the spotlight on the issue of excessive guarantee, and widespread disorder in the guarantee market became a central topic for public discussions once again.
It is reported that as of the end of 2015, outstanding non-performing loans (NPLs) provided by banks for enterprises totaled CNY 1.19 trillion, up 47.8% year-on-year, and the NPL ratio stood at 1.8%, up 0.45 percentage points from the same period last year.
As credit risks spread from east to west following a bottom-up pattern, defaults occurred at an increasing number of State-owned enterprises (SOEs) – some of them directly managed by the central government (known as “central enterprises”). Most of them specialize in overcapacity industries such as steelmaking. They are frequently suspected of “evading debts” through bankruptcy and reorganization, or forcing debtors to talk to lawyers for legal assistance.
Generally speaking, breaches of debt obligations committed by private companies tend to be large in quantity but small in value. The amount involved is around CNY10 million in most cases. By contrast, the number of SOEs breaching their debt repayment obligations is relatively limited, but the amount involved in each case tends to be very large – usually tens of billions or even hundreds of billions of Yuan, resulting in far-reaching adverse effects.
SOEs breaching debt obligations has a major negative impact on investor confidence. If a company goes bankrupt and is reorganized, it is supposed to improve its governance structure and liabilities. These days, however, bankruptcy and corporate reorganization are used as an excuse for the sole purpose of avoiding servicing debts owed to banks.
The China Banking Association (CBA) issued the Administrative Measures for the List of “Organizations Escaping and Revoking Bank Debts” twice in 2006 and 2013. It is pointed out in the 2013 amended version that there are eight types of “debt evasion”: escaping and revoking bank debts through restructuring, reorganization, merger, division, capital injection or reduction, dissolution or bankruptcy, or by illegally withdrawing, concealing or transferring assets; concealing important matters or material financial changes that may affect scheduled bank debt service payments, and information falsification; obstructing law enforcement by judicial authorities or normal inspections by banks by various illegal means, thereby infringing on banks’ rights as creditors.
Given the economic downturn and the general trend toward capacity reduction and destocking, instances of “debt evasion” among SOEs and central enterprises merit particular attention. The CBA reported relevant issues to the State-owned Assets Supervision and Administration Commission (SASAC) at the request of its members, proposing that leaders of the State Council pay more attention to the issue of SOEs escaping and revoking bank debts through restructuring or reorganization.
“Debt evasion” can generally be done through various means, including assets transfer, flight, leasing collaterals, divestiture of high quality assets and abrupt bankruptcy reorganization without notifying creditors, among others.
The issue has come to the attention of the central government and relevant regulatory authorities. During an executive meeting held on January 27, the State Council decided to support banks to speed up the disposal of NPLs and punish offenders of deliberate debt evasion.
On April 21, the People’s Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission jointly promulgated the Opinions on Supporting the Iron and Steel Industry and the Coal industry to Resolve Overcapacity and Achieve Turnaround in Development, stressing that efforts should be made to facilitate the introduction of an inter-departmental reporting system concerning dishonest enterprises and an inter-departmental joint discipline mechanism, thereby effectively curbing deliberate debt evasion and “deliberate breaches of guarantee obligations” among steel and coal enterprises.
To find out more about NPL-related risks exposed through the HFIHG incident, we interviewed Yuan Chao, Partner of Commerce & Finance Law Offices, who acted for several non-banking financial institutions to handle NPLs involved in the HFIHG case.
Yuan gave an analysis based on his experience of the case first-hand, and put forward solutions to similar cases.
Commentary on the guarantee crisis at Hebei Financing Investment Holding Group and suggestions to crisis mitigation
Firstly, lenders need to tighten up pre-lending risk control audit to minimize risks. Indiscriminate lending should be avoided. The key to a successful solution, however, is to ensure effective post-lending review. Take loans granted to projects for example. The authenticity of the project and every relevant transaction (by examining the authenticity of value-added tax invoices, for example) should be verified; funds should be paid to suppliers or downstream companies – instead of being directly credited into the borrower’s account; a real-time post-lending regulatory mechanism should also be in place, allowing the lender to suspend or terminate loan disbursements as and when irregularities are found in loan use.
Secondly, the guarantor should assess both the borrower’s solvency as well as its own ability to compensate the lender if the borrower defaults, rather than forcing other companies to settle the loan by borrowing new loans – it would lead to a snowball of loans, and the crisis would go out of control once it surfaces.
Thirdly, policymakers should provide more guidance regarding the most fundamental infrastructure for bank loan operations. Efforts should be made to improve bank’s lending system, ensuring that loans are granted to enterprises in actual need of financing. It overlaps with point one above, that is, to further develop the post-lending regulation mechanism to reduce the NPL ratio. All this cannot be achieved by relying on banks, financial institutions and SOEs due to their inherently profit-driven nature. Therefore, relevant legislation should be introduced and policy guidance by the China Banking Regulatory Commission and its local office is needed. For example, well-targeted requirements and incentives can be implemented to encourage banks to lend to small and medium-sized enterprises, supplemented with an effective post-lending regulation mechanism and relaxed eligibility criteria for loan applicants. In addition, SOEs and listed companies should be restricted from disbursing loans under various excuses. Policies must be consistent, requiring government officials to have a long-term approach rather than focusing only on shortsighted benefits within their own terms of office.
The guarantee crisis at Hebei Financing Investment Holding Group has given rise to a wave of widespread loan defaults. In my opinion, the crisis can be tackled from the micro and macro perspectives:
On the micro level, wherever possible lenders should obtain in-kind collaterals – ideally, highly liquid collaterals – from borrowers before granting loans. In the event of a default, lenders should initiate legal proceedings as early as possible to apply for property preservation. This requires that the employees in charge of loan disbursement pay close attention to property evidence associated with the borrowers throughout the transaction process.
On the macro level, since the onset of the crisis, bad loans directly guaranteed by Hebei Financing Investment Holding Group totaled over CNY 60 billion, and the consequent bad loans in Hebei Province amounted to over CNY 300 billion, affecting more than 100 enterprises within the province. To resolve the crisis, local governments should take the lead in bailing out high quality enterprises and, at the same time, shutting down a group of enterprises suffering from severe overcapacity with poor development prospects. It would awaken investors to possible devastating consequences, and prevent them from being unrealistically optimistic. Secondly, the debtor-creditor relationship must be straightened out. In addition to borrowings from financial institutions, these enterprises also took out loans from private lenders at interest rates higher than the standards prescribed by law. Such private loans need to be settled to remove part of the burdens shouldered the enterprises. Thirdly, relevant policies should be introduced to bail out competitive enterprises badly affected by the debt crisis through joint efforts with financial institutions and other local industry leaders. As well as helping them out, one or two companies should be listed on the stock market if possible, thereby restoring confidence among local businesses in Hebei.
In my opinion, the following issues should be tackled to permanently eliminate relevant risks at source:
Firstly, lenders need to tighten up pre-lending risk control audit to minimize risks. Indiscriminate lending should be avoided. The key to a successful solution, however, is to ensure effective post-lending review. Take loans granted to projects for example. The authenticity of the project and every relevant transaction (by examining the authenticity of value-added tax invoices, for example) should be verified; funds should be paid to suppliers or downstream companies – instead of being directly credited into the borrower’s account; a real-time post-lending regulatory mechanism should also be in place, allowing the lender to suspend or terminate loan disbursements as and when irregularities are found in loan use.
Secondly, the guarantor should assess both the borrower’s solvency as well as its own ability to compensate the lender if the borrower defaults, rather than forcing other companies to settle the loan by borrowing new loans – it would lead to a snowball of loans, and the crisis would go out of control once it surfaces.
Thirdly, policymakers should provide more guidance regarding the most fundamental infrastructure for bank loan operations. Efforts should be made to improve bank’s lending system, ensuring that loans are granted to enterprises in actual need of financing. It overlaps with point one above, that is, to further develop the post-lending regulation mechanism to reduce the NPL ratio. All this cannot be achieved by relying on banks, financial institutions and SOEs due to their inherently profit-driven nature. Therefore, relevant legislation should be introduced and policy guidance by the China Banking Regulatory Commission and its local office is needed. For example, well-targeted requirements and incentives can be implemented to encourage banks to lend to small and medium-sized enterprises, supplemented with an effective post-lending regulation mechanism and relaxed eligibility criteria for loan applicants. In addition, SOEs and listed companies should be restricted from disbursing loans under various excuses. Policies must be consistent, requiring government officials to have a long-term approach rather than focusing only on shortsighted benefits within their own terms of office.
The guarantee crisis at Hebei Financing Investment Holding Group has given rise to a wave of widespread loan defaults. In my opinion, the crisis can be tackled from the micro and macro perspectives:
On the micro level, wherever possible lenders should obtain in-kind collaterals – ideally, highly liquid collaterals – from borrowers before granting loans. In the event of a default, lenders should initiate legal proceedings as early as possible to apply for property preservation. This requires that the employees in charge of loan disbursement pay close attention to property evidence associated with the borrowers throughout the transaction process.
On the macro level, since the onset of the crisis, bad loans directly guaranteed by Hebei Financing Investment Holding Group totaled over CNY60 billion, and the consequent bad loans in Hebei Province amounted to over CNY300 billion, affecting more than 100 enterprises within the province. To resolve the crisis, local governments should take the lead in bailing out high quality enterprises and, at the same time, shutting down a group of enterprises suffering from severe overcapacity with poor development prospects. It would awaken investors to possible devastating consequences, and prevent them from being unrealistically optimistic. Secondly, the debtor-creditor relationship must be straightened out. In addition to borrowings from financial institutions, these enterprises also took out loans from private lenders at interest rates higher than the standards prescribed by law. Such private loans need to be settled to remove part of the burdens shouldered the enterprises. Thirdly, relevant policies should be introduced to bail out competitive enterprises badly affected by the debt crisis through joint efforts with financial institutions and other local industry leaders. As well as helping them out, one or two companies should be listed on the stock market if possible, thereby restoring confidence among local businesses in Hebei.