Insight: Chinese creditors find even state-backed credit protection has its limits

By Shu Zhang and Matthew Miller

BEIJING (Reuters) - Since the collapse more than two years ago of China's second-biggest loan guarantor, the state-backed Hebei Financing Investment Guarantee Group, creditors including powerful financial institutions have been trying to get billions of dollars of their money back. They have failed.

The creditors say they have been stonewalled by the group, including its most important stakeholders, the Hebei provincial government and the local office of SASAC, a state-run organisation that manages government assets.

"Basically, financial institutions are all trapped with a feeling of powerlessness when dealing with defaulting big state-owned enterprises," said one manager who works for a national institution and who travelled with a group of creditors to the northern region to urge authorities to produce a debt-workout plan. Reuters spoke to more than a dozen creditors of Hebei Financing for this story.

The sides have not even been able to agree on how much debt is owed by Hebei Financing. When Hebei Financing collapsed, it said it owed 32 billion yuan ($4.83 billion), but nine creditors told Reuters that they estimated the debt was as high as 60 billion yuan.

The Hebei provincial government and the Hebei office of SASAC, or the State-owned Assets Supervision and Administration Commission, did not respond to several requests seeking comment. A Hebei Financing communications official declined to comment.

The experience of these creditors is a cautionary tale in a country where for decades state debt has been considered as good as guaranteed.

China's debt has soared since the global financial crisis to well over twice the size of the economy, much of it the result of borrowing by state companies, leading to a rise in state defaults.

But Hebei Financing's collapse shows that the financial protection of the state has its limits and state-backed does not necessarily mean immediate payment for creditors.

Instead, other factors play a role, complicating attempts to develop a debt workout plan. These include the local government's fiscal position and its reliance on the indebted company for tax revenues and local employment and whether the central government gets involved. Courts are usually reluctant to hear a case, pushing creditors back to seek redress from the debtor.

While private firms can be pushed into bankruptcy, a state default is a much more tangled affair with many state institutions and differing degrees of willingness to support a failing state firm, said Ying Wang, senior director of Asia-Pacific corporates coverage at Fitch Ratings.

"The sanctity of state debt as risk free is now being eroded," Wang said. "The idea has definitely changed, as investors have seen cases of state-owned enterprise defaults," she said.

China's debt has risen so fast that The Bank for International Settlements warned last year that China was heading for a banking crisis and in August this year the IMF described debt levels as "dangerous", although the central government is enforcing a policy of debt reduction.

Based on bond data, defaults by state firms are on the rise and as a proportion of overall defaults are the fastest-growing in China. From zero defaults in 2014, they jumped to 28 in 2016 on more than 19 billion yuan of debt, according to data from China Chengxin International Credit Rating Co.

Bonds provide just a small window into the growing problem of state defaults because most credit by far is in the form of bank lending.

Debt guarantee firms like Hebei Financing were set up in China largely to support the private sector, the country's biggest investor and urban employer. Without a debt guarantee, many private firms are viewed by the state-dominated banking sector as too much of a credit risk to be offered loans at viable rates. Ironically, banks prefer to lend to state firms on the basis that their credit worthiness is guaranteed.

About a third of China's 7,000 debt guarantee companies are state-run. Moody's ratings service estimated state and private debt guarantee companies backed about 2.2 trillion yuan in debt at the end of 2016.

"POWERLESSNESS"

Hebei Financing collapsed after the region's economic growth slumped from more than 11 percent in 2011 to 6.5 percent in 2014. Failing to anticipate the slowdown, thousands of firms defaulted on their loans.

As defaults piled up and financial institutions turned to Hebei Financing for repayment, the company stopped honouring its pledges to around 1,000 firms, wreaking widespread havoc on the gritty region of steel mills and factories north of Beijing.

In October 2015, the chief executive of a Beijing-based asset management firm was stabbed by a frustrated investor who lost money in defaulted products guaranteed by Hebei Financing.

Creditors said that since Hebei Financing's collapse, there has been little meaningful communication. The company and provincial government have refused to release information on the company's financial position, its clients and has ignored pleas for a formal debt restructuring process, several creditors said.

Feeling frustrated and ignored, a group of creditors decided to take action in September 2016. Executives from these companies, which included a state-owned bank, state-owned and private securities, trust firms and asset managers, travelled to Hebei unannounced, hoping to meet with Hebei Financing officials, who had refused previous requests for a meeting.

The first three meetings of four planned that day were no shows. Officials from Hebei Financing, the Hebei provincial government and its bureau of finance declined to meet the executives, these creditors said.

But the final meeting of the day seemed to hold out more promise. An official from the local office of SASAC, Hebei Financing's biggest shareholder, said he would talk with the creditors - at the reception of the SASAC office.

What happened shocked the creditors, they said. Instead of discussing the debt problem, the official told the group he couldn't help collect any of the debt and they should take their grievance to Hebei Financing, prompting some creditors to become angry.

"(We) don't have the right, or administrative authority to help collect your debts," the manager at the institution recalled the SASAC official as saying. "From the very beginning, your contracts weren't signed with SASAC, right?"

The manager recalling the meeting said "a sense of powerlessness was my deepest feeling. There wasn't even a communication channel."

IMPACT

The latest statement from Hebei Financing's parent group on Dec 23, 2016 said provincial departments and city governments were still working on the problem.

The collapse of Hebei Financing had a debilitating impact on companies that had relied on its guarantees.

One of those, Jialong High-Tech Industrial Co Ltd, a lighting glass maker in the coastal Hebei city of Qinhuangdao, has been left heavily in debt.

Its bank accounts were frozen as the head of the company was detained as part of the investigation into Hebei Financing. Contact numbers for Jialong did not work and Reuters could not ascertain the firm's legal representative.

To survive, the firm has cut its workforce to less than 200 from 1,500, workers said. Creditors and employees at the firm say it has postponed salary payments, although some workers are sticking by the firm.

"I have worked here since the very beginning," a man surnamed Kou said.

"In the old days, the company never delayed salary payments.

So I have faith in the company. That's why I'm still staying," he said.

(Reporting Shu Zhang and Matthew Miller: Editing by Anne Marie Roantree and Neil Fullick.)