Asia's SMEs May Face Big Debt Problems

A big wave of defaults could be forming among small and medium-sized companies in Asia, raising the spectre of a pile of bad loans at the region's banks and a further plunge in investor trust.

Troubling signs are already popping up. Several Hong Kong companies have shuttered factories in China, including home appliance maker BEP International and toy maker Smart Union Group.

They may not be the only ones. Exporters, property, shipping and retail companies could be hit because they racked up debt and expanded aggressively in the boom times, leaving them ill equipped for the bust being seen across Asia, analysts said.

Slowing economies are crimping cash flow and profits in the region, while access to capital has been severely constrained as the global financial crisis sparks widespread risk aversion, choking off lending for smaller companies which are in most need of funds.

"It's inevitable that default rates will rise in Asia as these companies are now struggling to obtain new debt capital or simply to roll-over their repayment obligations," said Scott Bennett, a Singapore-based fixed income fund manager for Aberdeen Asset Management.

"SMEs have less access to capital, both debt and equity, and they don't have large, untapped credit lines or the sizeable cash reserves that larger and more mature corporates have."

Small-cap stocks on Hong Kong's main index have fallen 63 percent so far this year, exceeding the 52 percent decline for mid-caps and the 38 percent falls for large-cap companies.

Meanwhile, the region's high-yield bonds have been among the hardest hit globally this year, even though there has been only a handful of defaults in the past several years.

A key measure of risk aversion for Asian "junk-rated" credit, the iTRAXX Asia ex-Japan high-yield index, surged to a record wide of 950 basis points this month, rising three-fold this year.

Some bonds are already trading at pennies to the dollar. Bonds due in 2014 for South Korea's Magnachip Semiconductor  were quoted at 6.5 cents to the dollar after Standard & Poor's last week cut ratings on the chip maker to CCC, well below investment-grade due to "severe liquidity problems."

Banks to Suffer
   
A wave of bankruptcies also runs the risk of hitting earnings at regional lenders, given their high exposure to SME loans, making them less likely to lend at precisely the time when companies need it most.

Asian banks excluding Japan already have the highest ratio of non-performing loans to total loans of any emerging market region, at 4.9, according to data compiled by ING.

Indonesia, Pakistan, Thailand, China, Malaysia and the Philippines all have above average ratios of non-performing loans to total loans among global emerging markets.

Andy Mantel, portfolio manager with hedge fund Pacific Sun Investment Management, recommended selling short China Construction Bank, Bank of Communications, and Bank of China, based on the increasing chances that bad loans on their books may multiply.

"We feel that valuations of Chinese banks are still too high because of slowing loan books, increased non-performing loan risks, and investment losses stemming from falling equity prices," he said in widely-read The Gloom, Boom and Doom report.

Hong Kong banks are also at risk, given that a recent spate of corporate failures in the region will only be the beginning, Citigroup warned in a report this week.

Price declines in once booming property markets are already putting pressure on banks' balance sheets. National Australia Bank, the nation's top lender, reported on Tuesday a quadrupling in bad-debt charges and warned of tough times ahead, with Australian growth slowing and key offshore markets in recession.

Issue of Trust
     
The trend could be particularly acute for other countries with already weakening banking sectors such as South Korea, where loan-to-deposit ratios are well above 100 percent.

Standard & Poor's last week put seven South Korean financial firms at risk of a ratings downgrade, noting in part the higher likelihood of defaults in smaller companies, a segment to which banks had increased loans aggressively in the past few years.

Governments are thus responding by opening the spigots to the SME sector. South Korea announced last weekend it would help smaller firms get some 12 trillion won ($9.17 billion) in loans, as part of its broader package to help the country's lenders.

In China, the government last weekend outlined policy priorities for the final three months of the year, which included encouraging banks to lend to SMEs and increasing export tax rebates on clothing, textiles and machinery.

But piecemeal moves fail to solve the fundamental question of trust, as a failure here, and another there, adds up to a plunge in confidence in the broader SME sector, analysts said.

"Holders of high yield bonds are concerned about maturity repayment default, but what we fear is a missed coupon payments and even fraud, and these events can happen at anytime," said Aberdeen's Bennett.

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