IIF RESEARCH NOTE

Chinese Corporates: High Leverage & Declining Profitability

Growing concerns about the health of the Chinese corporate sector
March 2014
CONFIDENTIAL
Since the beginning of the 2008-09 crisis, Chinas largest
corporates have had easy access to credit, fueling high levels of
investment despite declining profitability, leaving Chinese corporates with a large debt hangover. Chinese corporates are now
particularly highly leveraged, with almost 150% corporate
debt/GDP. While most of this debt is local currency, Chinese
firms have also over $850bn in FX debt outstanding, up from just
under $300bn in 2008. As a result, Chinese corporates now face
the challenge of managing their debt levels in a slow-growth
environment with tighter profit margins.

Chart 1
China: Large Corporates' Revenue Growth
percent
40

35
30
25

Revenue
growth

18

EBITDA
margin (rhs)

17

16

20

Chinese corporate balance sheets: declining profitability

15

The corporate sector remains under pressure: debt-torevenue ratios increased from below 50% in 2008 to an estimated 58% in 2013. Although growth in debt may be slowing, revenues have also declinedhence Chinas corporate debt-to-GDP
ratio is likely to have increased further.

10

Over the same period, Chinese corporate profit margins

have fallen from 17% to below 14% (Chart 1). The funds-fromoperations-to-debt ratio, a measure of debt servicing capacity,
had a similar trend. Declining profitability along with Chinese
governments efforts to curb the credit growth may put further
pressure on Chinese corporates debt-servicing capacity. Building materials, coal, transportation, metals and mining are particularly exposed. Moreover, the proportion of loss-making industrial companies has been rising, hitting 13.7% in November 2013
with more than 47,000 loss-making industrial companieslittle
improved from 2012 levels, and up significantly from a low of
9.4% at the end of 2011 (Chart 2).

percent

15
14

5
0

13
'08

'09

'10

'11

'12

'13f

Source: S&P

Chart 2
Share of Loss Making Chinese Industrial Companies
percent, 12m-mav
22
21

20
19
18
17

Higher funding cost in domestic local currency bond markets

16

Chinese corporate funding costs have risen in domestic local currency bond markets. Spreads for BBB+ rated Chinese
corporates have widened over 300bps since mid-2013 and over
400bps since mid-2011, though they have tightened around
50bps in February (Chart 3). To a lesser extent, spreads for higher-rated corporates have also widened (around 50bps for AAA
and 100 bps for AA and A-rated Chinese corporates). Given that
Chinese local-currency domestic sovereign yields have also risen
over 100bps since mid-2013, the widening in corporate spreads
is even more noteworthy. This will also weaken Chinese corporates debt servicing capacity. Loans remain the mainstay of corporate financing, while any spillover effect from rising bond
yields on loan pricing has been limited. In fact new Chinese bank
loans amounted to RMB1.2 billion in Januaryhighest since
early 2010.

15
14
13
12
Aug 09

Aug 10

Aug 11

Aug 12

Aug 13

Source: Bloomberg

Chart 3
Chinese 5-Year Local Currency Corporate Spreads
bps, to Chinese 5-yr sovereign yield
1,200
AAA
AA
A
BBB+

1,000

First onshore Chinese corporate default

800

The recent default of Shanghai Chaori Solar Energy Science

& Technology Co.the first ever onshore default for a Chinese
firmunderscores the potential risks associated with such a high
degree of leverage. Chinas bond market is the fourth largest in
the world, but there have been no defaults, as local governments or trust companies provided support, or banks were extending new loans rather than registering loans as bad assets.
However, as noted recently by Premier Li Keqiang, future default
on bonds and other financial products may be unavoidable.

600
400
200
0
'09

'10

'11

'12

'13

Source: Bloomberg, ChinaBond

(Excerpted from IIF Capital Markets Monitor, March 2014, author: Elif Aksoy,
zaksoy@iif.com, 1-202-857-3647)

Copyright 2014. The Institute of International Finance, Inc. All rights reserved. The contents of this report may be neither reproduced nor
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