Shadowland: China’s dirty secret
PUBLISHED: 01 Mar 2014 04:28:00 | UPDATED: 02 Mar 2014 05:23:09
The central Chinese town of Liulin went from rags to riches on the back of its rich coal reserves – then plunged just as dramatically as China’s steel-making boom came to an end. Photo: Qilai Shen
LISA MURRAY
In a dusty valley in central China at the end of a winding dirt track, 20 half-finished apartment blocks rise up from the mud, veiled in a mist of fog and pollution. Chinese characters etched into the mountainside proclaim this isolated 10 billion yuan ($1.8 billion) development project will “change the world”.
And just 12 months ago, teams of workers toiled around the clock to create the new metropolis, fortified by giant slogans urging them to “bleed, sweat but don’t cry”.
Now a single builder is left at the desolate site. He tells AFR Weekend that construction should have been finished more than a year ago but the money has dried up and all 800 workers left in search of a paying job.
This abandoned and eerie construction site, outside the coalmining town of Liulin in Shanxi province, is ground zero for China’s fast-growing “shadow banking” system. It is one of the biggest risks lurking in the global economy.
The brainchild of local coal tycoon Xing Libin, it was supposed to transform his humble birthplace into a hive of economic activity. The unfinished apartment blocks would have provided accommodation for the people working on Xing’s vast agricultural scheme involving hundreds of acres of nearby farms. In this idyllic new world, locals would tend to walnut trees, raise chickens, fatten cattle and farm fish.
Instead, Xing’s grand plans have left his coalmining company, Liansheng Energy Group, crippled under a pile of debts worth more than 30 billion yuan, almost a quarter of which was sourced from China’s poorly regulated trust sector.
Now the walnut trees are dying and the only cattle in the area are on fancy posters promoting the forgotten farming projects. Meanwhile, Xing’s demise has sent ripples across global markets as his struggle to pay back investors lays bare what is arguably the most serious risk to the world’s second-biggest economy this year – a major trust default. Such an event has been likened to a wake-up call on the scale of the Lehman Brothers’ collapse in the United States.
First default looming: strategist
David Cui, who has published extensive research on the issue for Bank of America Merrill Lynch, says it will probably be more like the less dramatic failure of Bear Stearns. That is, it will be an episode that changes peoples’ perception of risk but doesn’t lead to financial panic. Not straight away, clarifies the Shanghai-based strategist.
Cui’s view is that the first default will happen in the next few months and, once more defaults pile up, a tipping point will be reached in terms of public confidence. That’s when the credit crunch happens. On his reckoning, probably within a year. “This is no different from the sub-prime crisis [in the US],” he says, except that in China, it is highly leveraged companies rather than households causing the problem.
Global hedge funds already have a watch-list of maturity dates for troubled trusts, and China’s shadow-banking system was certainly the hot issue at last weekend’s G20 meeting of finance ministers and central bank governors in Sydney.
The world is nervous. China’s debt levels have been growing rapidly, with total outstanding credit rising an average 22 per cent a year over the past decade. Much of that growth has taken place in the shadow banking system. Assets under management by trust companies, for example, have more than tripled since the end of 2012 to over 10 trillion yuan. And Nomura economists estimate that 3.5 trillion yuan of trust products will mature this year. Already two trust products have been bailed out and at least another 10 are in trouble.
On the other hand, while China’s debt has been growing quickly, it is still not high by global standards. According to AMP, China’s total debt as a percentage of gross domestic product is 213 per cent, slightly lower than Australia’s. And China’s shadow banking system is still less than a third of the size of its formal banking sector.
Even so, trust defaults will be a hot-button issue for global markets this year, and Beijing knows it. People’s Bank of China boss Zhou Xiaochuan acknowledged the problem at the G20, while insisting it was under control. The China Banking Regulatory Commission, meanwhile, is setting up a trust product registration system to get a better handle on the risks involved.
Liulin at centre of fallout
So far, the fallout has been concentrated in the small (by Chinese standards) mining town of Liulin, with a population of 327,000. The two trusts that flirted with disaster last month before being bailed out by governments and financial institutions were backed by loans to local coalminers; Xing Libin’s Liangsheng and a smaller player, Zhengfu Energy, whose founder is in jail.
In keeping with the US sub-prime mortgage crisis analogy, Liulin is the equivalent of Florida or Las Vegas – a vulnerable pocket where the bad loans start and potentially spread to the rest of the country.
Traditionally a very poor area because of its location on the western border of Shanxi, away from the main train lines, Liulin came late to the coal boom. But its rich reserves of coking coal put it in good stead during China’s steel-making frenzy in the middle of last decade.
As the country rushed to build apartment blocks, hotels, railway tracks and bridges, coking coal prices soared to more than 2000 yuan a tonne, high enough to justify the costs of lugging coal around the country by truck.
Local entrepreneurs responded, buying up mines and transportation companies and pouring the profits into real estate development, lavish office headquarters and expensive cars. The money was easy. Trust companies bet that coal prices would stay high and excessive displays of wealth only encouraged them to lend the miners more money.
Xing’s Liansheng expanded at a rapid pace, more than tripling its assets to almost 47 billion yuan during 2012.
Apart from funding the grand but doomed overhaul of his local village, Xing funded big donations to local schools and a six-tower property development including a hotel in the centre of town.
Xing wasn’t alone. Other local miners were spending huge amounts of money on their own vanity projects as the Liulin contingent burst their way on to the country’s rich lists. Hummers and Bentleys became a common sight along the streets of this sleepy Chinese town.
Champagne days over
Perhaps the first sign that Liulin’s rise, and that of leading coalminer Xing, had spiralled out of control were reports about the excessive spending on his daughter’s wedding in early 2012.
Famous pop stars, a private jet to transport guests to the resort island of Hainan and a wedding dowry of three red and two white Ferraris reportedly contributed to a total bill of $13 million.
Another sign was the opening last year of The Coal Grand Hotel, a gleaming glass building in the middle of town, fitted out with an indoor driving range and swimming pool. Built by Chen Hongzhi, the 39-year-old owner of rival miner Lingzhi Group, it has struggled to fill its rooms ever since.
A deputy manager at the hotel says that initially its main customers were the children of the local coal tycoons, who would book out rooms months at a time to use at their leisure. But now even they have stopped coming. Another staff member says he has been paid just three out of the past nine months.
The timing was terrible for the town’s first-ever five-star hotel. Not only did its opening coincide with the government’s widespread austerity campaign banning public officials from expensive accommodation and dining, but it also came as coking coal prices were on the slide. In the past two years, they have more than halved.
The town’s fortunes reversed in line with the national steel industry and, unfortunately, it happened just when all of the debts became due. Cash flow problems are on display everywhere in Liulin. From the deserted reception area at the Coal Grand Hotel and its legion of bored staff polishing spotless marble floors to the idle workers standing around the many coalmines dotted on the outskirts of town.
Ten trusts on watch-list
One former coal truck driver says that during the town’s heyday he was paid up to $1800 a month, but he quit last year to work for a taxi company when his salary dwindled to less than $450. To emphasise his point, he drives past an empty loading dock which, he says, used to be crowded with trucks at this time in the morning, just two years ago.
In a worrying sign for the town, the driver says that among the local miners, Liangsheng is not in the worst shape. Workers at a nearby mine owned by Hongsheng Energy Group claim they haven’t been paid in eight months.
A watch-list is doing the rounds among hedge funds with the 10 most troubled trusts and their coming maturity dates. Three of the trust products are related to Liansheng borrowings and one, which is maturing on July 27, is backed by a loan to Hongsheng.
It appears that Liansheng will be rescued. On the Liulin scale of business, it was too big to fail. A restructuring plan was leaked to the state-run media last week, which includes fresh loans from the China Development Bank. Hongsheng, too, may be able to extend its coming repayment date, but the group has other trust loans.
Sooner rather than later there will be a default, says Cui. At first, the market won’t be too worried about contagion, but then “there will be more and more defaults which chip away at confidence”, he says.
“At a certain point, something happens and people lose confidence and then we have a credit crunch in the system.
“I think the government will react very fast, write off some debt, force some debt to convert into equity and hopefully we can recover quickly.”
with Lucy Gao
The Australian Financial Review
BY Lisa Murray
Lisa Murray Lisa is a China correspondent, based in Shanghai.
Stories by Lisa Murray
* China exports climbed 14.5% in July
* China court upholds Liu Han death sentence
* China cracks down on dual passport holders
* China to ban coal use in Beijing from 2020
* China’s creeping threat to Australian coal
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