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Most debt-strapped firms unlikely to benefit from China rate cut

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China's surprise interest rate cut could bring little relief to smaller firms struggling with the country's most worrisome debt burdens, as lenders increasingly look to favor its strongest and most solvent companies.

China's central bank cut its benchmark lending rates by 40 basis points to 5.6 percent late on Friday, but lowered deposit rates by only 25 bps to 2.75 percent.

This could keep funding access on a leash for small and medium-sized enterprises (SMEs) that are already struggling to repay loans and get credit, because narrowing interest rate margins will squeeze banks' profitability.

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"It makes sense for banks to lend to stronger borrowers to protect themselves from bad debt, as net interest margins will narrow," said Tracy Tian, China strategist at BofA Merrill Lynch.

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A study of Reuters data for 2,600 companies showed that 80 percent of companies with a debt/EBITDA ratio of above 5 - the level that gets credit analysts deeply concerned - were small caps or those with market capitalization of less than $2 billion.

That suggests the majority of those most in need of lower financing costs will be shut out.

"History has shown that interest rate cuts do not solve SMEs funding difficulties," said Xie Dongming, Singapore-based fixed income analyst at OCBC bank. "SMEs will continue to face difficulties in gaining access to funds."

While the rate cut will not necessarily prompt banks to extend more loans to stronger borrowers, they are at least likely to get more favorable terms on their existing debt, analysts say. Weaker firms are unlikely to see such benefits.

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Debt/EBITDA is widely used by ratings agencies to measure a firm's ability to service its debts. It gives analysts a rough idea of how long a company would need to pay off its debts, from its operating cash flows.

The Reuters data showed that United Mechanical & Electrical , a company with market capitalization of just over a $1 billion, would take more than 400 years to service its current outstanding debt at the present rate of cash generation.

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Chemicals company Shanxi Sanwei and aluminium products maker Ningbo Fubang Jingye Group, would take 285 years and 140 years respectively to meet their obligations at the current pace.

Smaller companies are suffering as China's full-year rate of economic growth is on track to undershoot the government's 7.5 percent target and mark the weakest expansion in 24 years.

And while the topline has suffered as a result of a slowing economy, margins are under pressure because of growing costs.

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According to a BofA Merrill Lynch report 52.8 percent of the companies reported year-on-year margin contraction compared with 51.6 percent in the last quarter and 51 percent a year ago.

"Chinese banks will likely seek to cut back credit allocations to these firms next year to reflect their clients' weakened balance sheets," said Peter Fuhrman, chairman of China First Capital, a China-focused investment bank.