When Small Businesses Get Loans They... Buy Property?

(Bloomberg Opinion) -- By offering cheap loans to small businesses, governments reason, entrepreneurs will continue to pay their employees. That should halt the economic fallout from the coronavirus outbreak. But so far, this endeavor has been a public relations fiasco and a logistics nightmare.

In the U.S., mom-and-pop businesses are having a tough time getting their hands on stimulus loans, which turn into grants if the money is spent on salaries. Meanwhile, bigger companies such as Shake Shack Inc. found administrative loopholes to receive millions (since returned), and even hedge funds and private equity firms want a slice of the $350 billion offered by the Small Business Administration, a pool that’s already run dry.

In China, too, subsidized small business loans have also become a cornerstone of stimulus. The central bank established 1.8 trillion yuan ($254.1 billion) of re-lending facilities, offering cheap funds to commercial banks, which in turn lend that out to small companies.

But much to Beijing’s dismay, instead of paying salaries or shoring up working capital, these enterprises seem to be using the proceeds to buy real estate. The People’s Bank of China on Monday asked commercial banks in Shenzhen to look into whether their borrowers used property-backed business loans for this purpose during the outbreak. In March, existing home prices in the tech hub rose 9.7% from a year earlier, the fastest pace in three years. This sudden frenzy makes little sense considering the local economy had ground to a halt, as venture capital funding dried out and tech workers lost their jobs.

In the past month, anyone in Shenzhen with an entrepreneurial streak has gone apartment hunting, because rates are simply too low to resist. This set of borrowers only needs to pay up to 4.5%, according to Caixin, a financial news outlet. In addition, the Shenzhen government is offering to reimburse up to 70% of interest payments, as long as you’re a first-time borrower who runs a technology startup. All told, an entrepreneur could borrow a large chunk of her existing property’s market value at as little as 1.35%, well below the average mortgage rate of 3.25%.

Meanwhile, knowing that small enterprises have become Beijing’s top policy directive, commercial banks and the Shenzhen municipal government are eager to oblige. The Big Four lenders are being asked to grow their small and medium business loan books by another 20% this year, after a 55% jump in 2019, so they are approving whatever that comes to their desks — especially since these loans are backed by property. As for the Shenzhen government's parameters, almost every company could be eligible for the generous subsidy so long as its research and development expenses exceed 4% of sales, and over 60% of revenue comes from the broad industry category of “high-tech innovative industries and services.”

It’s worth asking why entrepreneurs are using the proceeds this way. An alternative could be to plow into the Shenzhen stock market, which is offering positive returns this year. Some business owners may well be doing so, but real estate always has a special space in China Inc.’s heart.

Of over 3,800 listed non-financial companies in mainland China, more than 40% hold property as investments, even though their business operations have nothing to do with the sector, data compiled by Bloomberg show. This certainly isn’t the case in the U.S.

In China, owning these assets is essential to survival. Even by the central bank’s own admission, its big lenders have become “pawn shops,” willing only to lend to large private businesses with sufficient physical collateral.

So if you’re a technology startup facing a slowdown, but the bank is offering you some cheap cash, the best course of action may be to buy another apartment. This way, when the economic outlook brightens down the road, you can use that property to take out bank loans.

As for the big banks, you can’t necessarily blame them for behaving this way. They don't make any money at the rates they’re being asked to charge. CLSA Ltd. has crunched the numbers: By the end of 2019, the average loan rate for small and medium-size enterprises was lowered to 4.75%, but once we account for banks’ own funding costs (1.77%), the money set aside to cover soured loans (2.3%) and operating expenses (0.8%), these financial institutions are barely breaking even. If they want to lend at all, they naturally prefer to have solid physical assets as collateral.

Offering subsidized small business loans at the government’s directive is a tiresome job for commercial banks everywhere. In the U.S., the largest will prioritize their bigger corporate clients. In China, lenders just want to rubber stamp their decisions and make the tedious task disappear, without checking whether proceeds are being used for their intended purposes. A lot of heavy plumbing will have to be done on both sides of the Pacific for these programs to work.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

©2020 Bloomberg L.P.