China’s growing corporate- bank nexus is toxic mixture of risky interdependence

The ever- closer relationship between Chinese companies and banks can be a toxic mix. A growing number of companies in China are buying into local lenders that need to raise capital. The interdependence is risky.

One danger is that banks lend to their corporate shareholders on more lenient terms than to regular borrowers, regardless of credit risks. That concern sparked a selloff in Jilin Jiutai Rural Commercial Bank’s stock on Monday, the first trading day following an 85 percent plunge in the market value of shareholder China Huishan Dairy Holdings Co. The milk group’s chairman controls the company through an entity that also owns more than 15 percent of Jilin Jiutai’s Hong Kong- listed stock. The lender in turn is Huishan’s second- largest creditor, with some $ 262 million on the line, according to Caixin.

Losses can flow the other way as well, as corporate equity injections bind banks and companies closer together. Take Yanzhou Coal Mining, for example. The group bought about 2.2 percent of China Zheshang Bank in the mid- sized lender’s Hong Kong IPO a year ago. Since then, the miner has boosted its holding to about 2.8 percent, currently worth about $ 254 million, according to Reuters Eikon data. Yanzhou Coal made that investment even as it grappled with more than $ 7 billion of net debt in a sector that is suffering from massive overcapacity.

There’s no suggestion that Zheshang is in trouble, but risks are mounting. Shaky “special mention” loans swelled more than 50 percent at the end of 2016 from a year earlier. That’s on top of debt officially classed as non- performing which amounts to 1.3 percent of total loans. More trouble is brewing in Zheshang’s $ 78 billion portfolio of investment receivables – often loans disguised as investments. Writing off less than 2 percent of those assets would wipe out the bank’s 2016 net profit. In that scenario, Yanzhou Coal’s invest- ment would take a hit, further undermining its own creditworthiness.

The corporate- bank nexus may spare the government from directly injecting capital into banks. But when things go wrong, the authorities will still have to pay the price for letting bad companies prop up bad lenders.