Credit Guarantees Yet Again, In Shandong

Bloomberg: Defaults in One of China’s Richest Provinces Spook Investors

The problem isn’t the defaults themselves -- other provinces have seen more and worse. It’s the practice common among Shandong companies of guaranteeing each others’ debts. Firms don’t have to make public these liabilities, leaving investors to wonder who’s on the hook and for how much. With the once-strong industrial economy flagging, the murky ties between the province’s private companies threaten to drag them all down together.

This is one of many challenges bond investors must grapple with in China now, after defaults onshore climbed from zero just a few years ago to 130.7 billion yuan ($18.7 billion) in 2019. In Shandong and elsewhere, it’s still unclear how the government will intervene. Policy makers have been increasingly willing to let weak companies fail, but they’re also under pressure to keep the economy growing and the markets stable.

As of now, Shandong’s city and local governments have stepped in with piecemeal relief. It’s uncertain whether the provincial government will do the same. As a result, the province’s firms risk entering a vicious cycle that “spreads solvency risks to the entire region, swamping the good credits along with the bad,” according to an October report from S&P Global Ratings.

There are two main forms of credit guarantee blow-ups. One is a key firm goes down, triggers default protection and banks start calling in loans on many companies in the industry or geographic region. The other is a credit guarantee firm, running a business model similar to AIGs before 2008, goes bust.

This is not a new problem. China dealt with worse in 2014/2015 and papered over the problem. Since the prior cycle, governments became active in providing credit guarantees. Lately it has been aimed at science and technology firms. See 中南建设：为7家企业提供共计30.95亿元担保 and 辽宁五市设立科技融资担保公司 科技型企业将享专业化融资担保服务 If the economy picks up, they should have little trouble doing the same.

For those keeping time at home, credit guarantee blowups came in the earlier part of the economic downturn last time and peaked near the end of the downturn in China. Global financial markets would not bottom for another 6 to 8 months. Is trouble in Shandong an outlier event at the end of a downturn or a sign that a larger magnitude downturn is underway? We'll soon find out in 2020 once the initial blast of rushed infrastructure spending wears off.

Prior coverage

2014

Rumored Mass Death of Companies in Xiaoshan District of Hangzhou If Banks Collect on Debts; Government Tells Banks to Sit Tight or Leave
Ye Tan's Commentary on Xiaoshan: Get Government Out of Credit Markets
Steel Trade Lawsuits Explode; Banks' Unceasing Nightmare; Defendants Flee
Credit Guarantee Firms Go Down Like Dominoes
Credit Guarantee Nightmare; How The Qingdao Port Scandal Goes Viral
Largest Privately Run Credit Guarantee Firm in Sichuan Goes Bust


2015

The Credit Dominoes Are Falling Again; Northeast Faces Deflationary Collapse Without Bailout
Hebei Credit Collapse: State Owned Credit Guarantee on the Brink as AIG Business Model Falters

"The profit model is an important reason for the large-scale collapse of credit guarantee firms, a 2% profit is not sufficient for taking on 100% of the risk."

Shandong has seen credit guarantees blow up before, in 2017: Shandong Bad Debt Daisy Chains Exploding, Loanshark City Falls on Hard Times

A blanket of liquidity covered up bad debt for more than a year, but "neutral" monetary policy has revealed the underlying problem once more. iFeng has an entire special section devoted to Shandong's exploding daisy chain