China further limits private lending rates

The decision to cap the private lending rate may increase competition for quality borrowers and reduce interest margins and profitability, say analysts at Fitch Ratings.

As a follow up to its key regulations on private lending in 2015, the Chinese government has made changes to its private lending rate that affects non-bank private lenders across China.

China’s Supreme People’s Court decided to cap the private lending rate at four times the loan prime rate as of 20 August. The latest court decision would limit the private lending rate to a maximum of 15.4 percent, based on the current loan prime rate which is on a floating basis, as per an official statement by the court, citing He Xiaorong, deputy ministerial member of the judicial committee.

The change applies to non-financial entities that are engaged in loan business, according to the statement. The new effective cap rate, of up to 15.4 percent, is a decrease from the previous cap of 24 percent. The base rate of the loan premium rate cap will be released every month, according to reporting by Xinhua, the state-backed news agency.

Previously in 2015, the private lending interest rate cap in China was between 24 and 36 percent, according to the court statement.

It is still unclear to what degree the cap will impact private debt fund managers and non-bank lenders in the region with exposure to China or to the broadly structured credit market.

Jintao Liu, a Hong Kong-based head of credit investment at ARTE Capital Management, an investment firm focused on distressed and structured credit investments across the greater China region, told Private Debt Investor that the court’s interpretation has greater impact on onshore distressed investors and lenders that make Chinese yuan-denominated loans, considering the applicable jurisdictions of private loan documents.

Analysts at Fitch Ratings said China’s non-bank lenders could be adversely affected by the Supreme Court’s decision to cap the private lending rate. According to Tracy Wan, senior director of Asia-Pacific structured finance at the ratings agency, lenders may use the rate cap to determine pricing limits and screen customers by credit risk.

“This may increase lenders’ competition for quality borrowers and reduce lenders’ interest margins and near-term profitability, although the effect should ease over the longer term as less competitive lenders exit the market,” she told PDI.

Wan added that the rate cap could also aggravate asset-quality pressure for lenders if the cap reduces funding availability for high-risk borrowers to repay existing debt. “Another risk is that lenders could issue credit to some borrowers at rates that do not reflect credit risk appropriately, giving rise to asset quality problems in the medium term,” she noted.

Asked if analysts at Fitch see any leeway for private lenders to boost the lending rate beyond the ceiling or to compensate the reduced interest margins by charging more upfront fees, the agency’s spokesperson declined to comment further.

Another interpretation of the private lending cap, Liu noted, is on an “all-in cost” basis, meaning charging more upfront fees is not an option for private lenders in China.

“The new law interpretation will be applied retrospectively to cover the loans that have not been judged,” he said, adding that there is an uncertainty evolving around the bankruptcy situation as well.

The rate cap has been in effect since 20 August, according to Wan.

PDI data show that among the private debt fund managers in the region, Abax Global Capital, ADM Capital and CLSA Capital Partners look to invest in the mid-market lending sector or consumer loans via structured credit.

Abax Global has a China-focused growth capital lending strategy which was backed by the University of Michigan, an Ann Arbor, US-based endowment, as per PDI reporting in June 2019. The US endowment has committed $50 million to Abax Asian Structured Private Credit Fund III.

As per PDI reporting in November 2018, ADM Capital garnered $178 million for its second Asia-focused lending fund, Asia Secured Lending Facility II. China was one of the vehicle’s geographic focuses among other Asian countries.

CLSA Capital Partners’ pan-Asian secured private lending platform, Lending Ark, also looks to invest in consumer loans among other segments such as small and medium-sized enterprise loans and trade finance, according to company disclosures.

CLSA Capital Partners declined to comment on the reporting. Requests for comments to ADM Capital Partners and Abax Global were not returned by publication time.

According to Liu, the activities of financial institutions, such as distressed loan purchases by financial institutions, are not subject to the latest lending rate cap.