CHINA is permitting banks to offer loans for mergers and acquisitions for the first time since 1996, hoping to spur corporate activity amid a global credit crisis that has dried up financing for takeovers in many developed countries.

The China Banking Regulatory Commission in December issued guidelines for M&A credit as part of the 4 trillion yuan (US$586 billion) government stimulus plan to try to boost economic growth and improve credit liquidity.

"It's a breakthrough," said Huang Fuxing, director of the securities and futures center at the Shanghai Academy of Social Science. "The loans are aimed at accelerating M&A activities at big state-owned enterprises where consolidation is being encouraged."

Shanghai Pudong Development Bank and other lenders that meet the guidelines say they are now processing applications from companies seeking to acquire other firms.

Fire-sale prices

"Our bank has seen a lot of interest, mostly from manufacturing companies," said Lai Jianping, from Shanghai Pudong Development Bank. "Some large, cash-rich industrial companies see opportunities in less successful companies that are close to collapse and willing to sell assets at fire-sale prices.

"Large companies can make use of their strong capital during the tough times to strike real bargains and pave the way for expansion when the storm has passed," said Lai, who is based in Tianjin.

The bank has already signed a cooperation deal with the China Beijing Equity Exchange on finding M&A projects.

Huang Yi, a China Banking Regulatory Commission official who was the main author of the new loan guidelines, said that the economic slowdown accelerated the government's plans to open bank loans for M&A activity. Such loans were previously banned because the regulator was concerned that many banks would be saddled with bad debts from a heyday of ill-advised lending to enterprises with poor balance sheets.

"We aren't seeking to encourage high leverage and we aren't encouraging mergers and acquisitions in industries that go against the grain of the national strategy," he said.

The new guidelines are designed to steer money to credit-worthy clients. The rules require that a company put up at least 50 percent of the money for a merger or acquisition. They also restrict M&A lending to financial institutions with capital adequacy ratios of 10 percent of more.

M&A loans are seen as a lifeline for Chinese banks, which rely on interest income as their main source of revenue. The banks, which accrue about 70 percent of their income from interest, have been squeezed by five consecutive cuts in official rates.

"The new M&A loans will push banks to seek more lucrative business rather than relying on interest income," said the Shanghai Academy's Huang.

The guidelines are meant to reinforce government strategies aimed at curbing heavy industrial polluters and high-consumption sectors, such as small steel mills that use a lot of coal. Environmentally friendly industries are encouraged by the government.

First loan granted

Industrial & Commercial Bank of China issued the first M&A loan in China to Beijing Capital Co for a water treatment acquisition, with a loan estimated to be 5 billion yuan. The Beijing firm has set its sights on being the leading water treatment company in China and is keen to expand.

China remains the largest economy that has fended off recession in the current financial crisis, but its export sector has slowed dramatically because of a drop in consumption and a squeeze in credit markets in developed countries.

The economy grew 6.8 percent in the fourth quarter of 2008, the slowest in seven years. State authorities are maintaining an 8-percent growth target for 2009.

"The financial crisis brings both challenges and opportunities," Su Ning, vice governor of the People's Bank of China, said in a report issued at an M&A loan forum in Shanghai earlier this month.

"The seizing-up of markets and too much leverage caused the global financial crisis, which originated in the United States," he said. "Chinese financial markets, by contrast, have little leverage. More economic reforms can be implemented on a trial basis while the economy is slowing."

Industry officials are hailing the new regulations as timely assistance.

"We need more access to credit and the M&A loan comes as a fresh option," said Jin-Goon Kim, director of China Grand Auto. "These tougher economic times require us to be more nimble in seizing opportunities that might strengthen our operations."

The company has several merger targets on hand and is talking with two banks, one from Shanghai, on acquiring loans to enable the projects.

Expansion through merger and acquisition is part of the company's strategy. China Grand Auto, an auto dealer, is targeting companies with strong assets, not companies near collapse.

But the economic downturn has been an advantage to the company as it now enjoys greater bargaining power.

Regulators, banks and the corporate sector have all called the introduction of M&A loans a step forward.

Still, there are risks. China's banks have the money for mergers and acquisitions but they lack personnel experienced in such sophisticated deal-making. Trying to recruit experts from overseas runs the risk of bringing people on board who don't understand the intricacies of how China does business.

M&A loans bring higher returns but also carry higher risks. Huang at the Shanghai Academy says the risk may make banks cautious at first about approving M&A financing.

Just the first step

Launching these loans is just the first step. It will be followed by more work such as tracking the corporate management of each M&A, as not all M&As will necessarily be successful.

Huang at the Academy of Social Science said that the new loan channels won't immediately benefit smaller companies because of the time and paperwork involved in making an application. But at least it's a start.

"It's too early to gauge the full effects of the new loan channel," Huang said.

But if nothing else, he said, it will help end the illegal backdoor use of third parties to secure corporate financing.

The evolutionary road of M&A financing in China ?? 2008

April: Su Ning, deputy governor of the central bank says trials of M&A financing can be made to boost the economy

May: M&A financing is allowed on a trial basis in the aftermath of the May 12 earthquake in quake-hit areas

June: At the China Mergers & Acquisition Association's annual meeting M&A loans are advocated

December 8: The State Council releases a document on the financial industry's support of the economy, including the green light for M&A loans

December 9: The China Banking Regulatory Commission issues guidelines for commercial banks to offer loans for M&A transactions

Source: People's Bank of China

M&A loans in China Q&A

What industries in China commonly have M&As?

Financial industries; manufacturing - for production capacity and technology; and retail - for retail networks, branding and consumer base.

Which industries in China can benefit from an M&A loan?

Industries encouraged by the central government to consolidate, such as the water treatment sector. Environmentally friendly industries are also encouraged.

Which banks can extend the loans?

Banks with a capital adequacy ratio, the main measure of banking strength, of more than 10 percent and provisions against bad loans of over 100 percent.

What's the upper limit of M&A loans in China?

Loans can cover up to 50 percent of the total value of a merger or acquisition.

What's the maturity of M&A loans?

Less than five years.

Source: Shanghai Daily research