SHANGHAI Call it the new China Syndrome: Although Asia's biggest economy is slowing down markedly, credit continues to surge. Dead-end projects and dying industries are sucking up an ever-larger portion of new credit, while more productive borrowers are starved for funds.
Nowhere is this more evident than in China's shadow banking sector, the non-bank financiers that have pumped credit into the economy at a spectacular rate. Trust companies - firms that sell investment products to Chinese savers and use the proceeds to make loans or buy other types of assets - have posted the fastest growth.
A Reuters examination of proprietary data shows that as little as half of trust loans issued in 2012 were used to finance current economic activity, such as a new investment project or increased production at an existing factory.
The other half may have been used for refinancing old debt that funded past projects but is no longer contributing to economic growth.
The finding offers a possible explanation for the growing disconnect between lending and growth in China. Many analysts have expressed concern that the so-called "credit intensity" of Chinese growth is increasing. Ever more borrowing is required to produce the same amount of economic output. But no one is sure why.
Rising credit intensity is exacerbating the huge buildup of debt in China's financial system since Beijing launched its credit-fueled 4 trillion yuan ($650 billion) stimulus plan in 2008.
Much of that money flowed into infrastructure, real estate, and new manufacturing capacity. Reuters found that local governments, property developers, and industries suffering from surplus capacity together account for about 70 percent of trust loans granted in 2012.
The 1979 movie "China Syndrome" was about a cataclysmic nuclear reactor meltdown. And some see excessive debt as a ticking time bomb that will eventually produce a wave of defaults and an economic meltdown. But the Reuters examination of the trust data points to a different, though equally worrying scenario: slow and debilitating atrophy.
The risk of pervasive debt rollovers is that China could follow the path of Japan in the "Lost Decades", creating a permanent class of "zombie borrowers" who have little hope of turning a profit but survive through continual injections of fresh credit.
Such perpetual refinancing avoids short-term economic pain by keeping factories humming and workers employed at infrastructure construction sites. But in the long run, zombies suck the lifeblood from the economy.
That is an especially big problem for China, where small- and medium-sized enterprises account for 60 percent of gross domestic product and around 75 percent of new jobs but have long struggled to get access to credit.
China's economic growth has slowed for 12 of the last 14 quarters, and 2013 is likely to be the slowest full-year growth since 1990, with the official 7.5 percent target seen ambitious and double-digit growth rates now considered firmly a thing of the past.
"(China's) economic growth since 2009 has been fueled disproportionately by a credit binge that left local governments and their state enterprises with a lot of debt they cannot repay," Arthur Kroeber, managing director of GK Dragonomics, a Beijing-based research firm, wrote in a recent research note. "The risk of Japan-style rot is substantial."
THE RISKIEST DEBT
Reuters analyzed 1,166 trust loans issued in 2012, using data purchased from Use-Trust Studio, a research firm based in Jiangxi province that has compiled the most comprehensive public database of trust and wealth-management products. Trusts surpassed insurance companies last year to become the second-largest sector of China's financial system by assets, behind commercial banks.
The trusts Reuters analyzed totaled 234 billion yuan, or roughly 8 percent of 3 trillion yuan in trust loans issued in 2012, Reuters estimates.
Trusts also comprise the largest component of China's shadow banking sector, which includes a range of non-bank lenders from securities brokerages to curbside loan sharks.
Trust loans offer a useful window into China's debt problems. Unlike banks, trusts typically disclose the identity of their borrowers in the marketing materials they use to attract investors, along with some detail on how the funds will supposedly be used.
But because trusts cater to borrowers who can't access credit from traditional banks or the bond and equity markets, the Use-Trust data also sheds light on the normally opaque world of shadow banking, where analysts fear the riskiest debt is hiding.
Trust loans represent the riskiest category of Chinese credit for which any significant data is available. Just beyond lies the murky world of informal lending.
"Right now trust financing is the financing method with the lowest barriers to entry in China. Of course, the cost will be higher," said Fan Jie, analyst at CN Benefit, a research firm that tracks China's trust and wealth-management industries.
The trust products that Reuters analyzed offer investors returns of 9-12 percent annually. That is even higher than the wealth management products that banks sell, which offer rates of 5-7 percent.
By the time the trust company takes its fee, typically worth 1-2 percent of the loan value, the local government or firm may pay up to 15 percent interest for a one- to two-year loan, more than double the bank rate of around 7 percent for similar loans.
The crippling interest rates make it even more difficult for borrowers to reduce their debt, laying the groundwork for future rollovers.
Only 4 percent of trust loans by value are explicitly intended for re-financing, Reuters found. But an additional 37 percent of trust loans specify the use of funds as "working capital", "liquid funding" or similarly vague terms that experts say sound like a rollover. For 8 percent of loans, disclosures offer no significant detail on the use of funds.
Local governments have ways to disguise the fact they are using new loans to repay old ones, said a Beijing-based trust company executive, who asked for anonymity. "When you're doing due diligence, you can figure it out, but no one will say it explicitly."
Tianjin, China's fifth-largest city, offers a glimpse into the plight of thousands of loss-making local governments and industrial firms that have turned to trust companies and other institutions that make up China's shadow banking system.
Reuters' analysis of the trust data, along with Tianjin's own disclosures about the financial condition of the city's largest financing vehicle, show how the city relied on high-interest funding to repay old debts.
About a half hour by high-speed train southeast of Beijing on the east coast, Tianjin was a lively trade centre in pre-Communist days, before becoming a grubby backwater overshadowed by the Chinese capital.
But since 2009, Tianjin has invested more than $160 billion in an effort to create a financial centre that would be China's answer to Manhattan - almost three times the amount spent on China's Three Gorges Dam, one of China's costliest projects.
The glitter and growth - 16.4 percent in 2011 - helped propel Tianjin's former Communist Party secretary, Zhang Gaoli, to a coveted seat on the Politburo Standing Committee, China's elite seven-member ruling body.
But the Yujiapu financial district, where 47 skyscrapers are being built, may prove to be China's biggest white elephant yet. It is not clear why major financial institutions, which already have offices in Beijing, would need to establish a large presence in Tianjin as well.
Indeed, at the start of 2012, Tianjin's main local government financing vehicle for infrastructure projects faced debt repayments of 56 billion yuan for the year, the city's public disclosures show. But the financing vehicle suffered negative cash flows every year since at least 2008, including a loss of 28 billion in 2011.
Like other cities, Tianjin used local financing vehicles to raise money as a way to skirt China's ban on direct borrowing by local governments.
While the marketing materials for the trust plans do not explicitly say that Tianjin would use the loans to repay old debt, the dates and amounts of the loans leave little doubt as to their true purpose.
In the spring of 2012, the city's largest financing vehicle, Tianjin Infrastructure Construction and Investment Group Co. Ltd., and a subsidiary took out trust loans worth 4 billion yuan, most at interest rates above 10 percent, Use-Trust data shows.
In the case of two billion yuan in loans from CITIC Trust, CITIC's website said the funds would be used for construction and "daily operations" of various infrastructure projects.
Yet CITIC Trust had good reason to suspect that Tianjin would actually use the funds to repay old debt. That is because CITIC itself was expecting repayment of principal and interest on 3 billion yuan worth of trust loans issued in 2009 that matured within days of when CITIC offered the fresh loans.
Wang Daoyuan, vice-president of CITIC Trust, said it is normal for a lender to provide fresh loans to valuable clients when old ones expire.
"Looking at these two trust products, it's hard to prove, for a company with debts of 200 or 300 billion yuan, which specific loan is being used to repay which other loan," Wang said.
Tianjin's main financing vehicle faces loan servicing costs totaling 246 billion yuan between 2013 and 2019, its disclosures show. After years of negative returns on its investment and little indication the projects can cover their costs any time soon, Tianjin will likely have to keep borrowing to stay current on its loans.
Tianjin's Financial Affairs Office did not respond to faxed questions seeking comment. The city's State-owned Assets Supervision and Administration Commission, which owns the Tianjin Infrastructure, the local government financing vehicle, did not respond to questions sent by fax.
Beyond local governments, companies from industries suffering a surplus of capacity are also prime candidates for debt rollovers. Reuters found that 10 percent of trust loans flowed to companies from sectors the central government has identified as suffering from overcapacity.
($1 = 6.1234 Chinese yuan)
(Reporting by Shanghai Newsroom; Additional reporting by Zhang Shengnan in BEIJING.; Editing by Bill Tarrant)