Concern grows at Chinese companies’ bad debts

October 15, 2013 5:39 pm

Concern grows at Chinese companies’ bad debts

By Henny Sender

Offering credit appears seductive, but the reality for investors is grim

Concern about Chinese companies’ bad debts is mounting. But, at the same time as these worries surface, a group of US, Hong Kong and Chinese investment concerns has decided that lending money to them is still an attractive business. Although China has just agreed to let UK-based institutions invest up to Rmb80bn (£8.2bn) in Chinese securities, opportunities to provide equity capital to Chinese companies remain scarce.After a scare in June – when Chinese regulators squeezed its banks and non-banks – liquidity has returned to the credit market. China has plenty of money, but the cost of capital is going up – which is why the prospect of lending money remains appealing.

However, if offering credit to Chinese companies that are not using the banks appears seductive, the reality for many investment businesses has been grim.

They have run into both legal difficulties over seizing loan collateral, and some Chinese companies’ disinclination or inability to pay. Unless it is structured very carefully, experience suggests that debt investing can prove as vexatious as taking equity stakes.

At the moment, at least on the surface, there is no sign that China fever is diminishing. But more foreign investors have concluded that investment in the country is becoming harder, rather than easier.

Take the case of Abax Global Capital, a Hong Kong investment company with links to both Morgan Stanleyand China Development Bank. It is locked into a bitter dispute with China Natural Gas, after lending the US unit of the Chinese company $42m.

Last year, the Xian-based gas distributor suspended payments on the debt. Abax then hired the law firm Weil, Gotshal & Manges to try to have the Chinese company’s US unit put into involuntary bankruptcy – the first time such a move has been attempted in the US.

China Natural Gas “is the typical company which has money but doesn’t see any reason why it has to pay its debts”, claims one person involved in the dispute.

But Louis DeLucia, a lawyer for China Natural Gas at Schiff Hardin in New York, says that the US unit filed for bankruptcy voluntarily in New York in July, and is now in the process of formulating a plan to repay its debts. It is working with its units in China to facilitate a restructuring. Meanwhile, the dispute continues to make its way through the courts.

However, the US Securities & Exchange Commission has also had issues with the company. China Natural Gas’s US unit – a Delaware-based entity that originally listed on Nasdaq in 2005 through a reverse merger with a pre-existing shell company – has been suspended from Nasdaq after “the fraudulent concealment of two related party loans and the failure to timely and properly report a material acquisition by Ji Qinan, the former chief executive of the company, and China Natural Gas,” according to a lawsuit brought by US regulators.

These related party loans involved two that ultimately went to Xi’an Demaoxing Real Estate Co, a property business 90 per cent owned by Mr Ji’s son, and 10 per cent owned by his nephew.

The SEC also alleged that Mr Ji lied to his own board about these loans and claimed the company could not refuse to make the loans “because they involved senior government officials who were in charge of the company’s liquid natural gas project”. At the time – in 2010 – the company had assets of well over $200m and operated profitably, according to quarterly reports filed with regulators.

Mr DeLucia says the Delaware company has paid a penalty to settle the case. Neither the company or Mr Ji admitted or denied the allegations.

Of course, there are plenty of other lenders that have entities onshore in China and licences that enable them to lend in renminbi and gain access to collateral in the country. They include Hong Kong based Pacific Alliance Group (now known as PAG) and Citic Capital, which has a renminbi lending operation on the mainland. But these are the exceptions.

Some Hong Kong hedge funds have found themselves locked in disputes over loans they have made to Suntech, the solar power company that Chinese banks threw into bankruptcy a few months ago.

A group of bondholders initiated an involuntary chapter 7 proceeding against Suntech Power Holdings in the US this week. Such cases are multiplying.

Even so, the number of overseas companies lending to Chinese groups continues to grow. One of the sayings of Chinese investors is that “the greater fool is he who does not believe in the greater fool theory”. In these cases, it seems easy to know who the greatest fool is.

Henny Sender is the Financial Times’ chief international finance correspondent

henny.sender@ft.com