BEIJING (Reuters) - Many privately held firms in Shandong, China’s third-biggest province by economic output, are struggling to repay short-term debt due to declining industry fundamentals, entangled cross guarantees and ill-managed investments, S&P Global Ratings said.

FILE PHOTO: A worker walks past steel rolls at the Chongqing Iron and Steel plant in Changshou, Chongqing, China August 6, 2018. REUTERS/Damir Sagolj

China’s slowing economy and enforcement of environmental protection rules have pressured the profitability and cash flow of Shandong companies in over-capacity sectors including oil refining, petrochemicals, steel, aluminium and textiles, S&P said.

“The Shandong economy is skewed toward gritty smoke-stack industries where companies are typically highly leveraged,” said Chang Li, China country specialist for S&P Global Ratings.

“We view the plight of Shandong POEs (privately owned enterprises) as indicative of China’s wider challenge: the difficulty of transitioning to a higher value-added economy, while managing high debt and slowing growth.”

Private firms in Shandong are also frequent users of the cross guarantee, which has the potential to send one company’s liquidity problems reverberating through the credit system, the ratings agency said.

Reuters reported in February, citing court rulings, that at least 28 private companies in Dongying, a hub for oil refining and heavy industry in Shandong, are seeking to restructure their debts and avoid bankruptcy, mainly due to souring loans that they guaranteed for other firms.

For a private firm to get bank loans in China, especially those in traditional, capital-intensive industries, it often needs substantial collateral or the guarantee of another company. The guarantor itself is very likely to have taken on loans guaranteed by other firms.

Complicating the situation is the weak transparency of these companies in disclosing their full exposures, potentially creating vicious cycles where complex cross guarantees spread solvency risks to the entire region, swamping the good credits along with the bad.

“We foresee no immediate relief to Shandong’s POE liquidity and refinancing challenges given China’s slowing economy. We expect Shandong POE credit risk will remain significant for the next 12 months,” S&P said.

The ratings agency added that Shandong’s support will be limited, as the provincial government has been favoring high-value-added sectors in recent years, and may not mind letting some private firms in over-capacity industries go under, if there is no systemic risk.