New red flag for China lending

Lenders spent nine months poring over the books, sizing up management and even checking out the factory floor at China’s Ultrasonic before deciding in August to give the Frankfurt-listed shoemaker an unsecured credit facility of US$60m.

The loan was unsecured, in keeping with regulations in China at the time it was structured. Nomura and its lending partners, however, felt they had done their homework.

However, within weeks, the three-year loan had been drawn down in full and two of Ultrasonic’s top executives had disappeared, leaving the lenders in a situation that should ring alarm bells for foreign bankers exposed to China.

“You couldn’t get onshore security for offshore loans,” said a person involved in the loan negotiations. “It was a common risk in offshore borrowing for Chinese companies.”

The episode is a reminder to offshore banks of the risk of lending to small and mid-sized Chinese firms, which have long struggled to access credit. Local banks are more inclined to lend to larger, more established companies as economic growth slows, forcing smaller firms to seek expensive loans in the less-regulated shadow banking industry or from offshore lenders.

At the end of last year, Asia-Pacific banks had about US$1.2trn worth of China-related exposure, including bank and non-bank lending, latest Fitch Ratings data show.

“These mid-sized companies are getting hit the hardest by the slight slowdown in the economy, and that’s having an impact on how they view the future …,” said Kent Kedl, Shanghai-based managing director for Greater China and North Asia at consultancy Control Risks.

“This isn’t to say that mid-sized companies have any more innately corrupt people in them than do large companies, but large firms can weather storms a little easier.”

China’s economy grew 7.5% in April-June, a touch quicker than the previous quarter’s 7.4% – the slowest since the third quarter of 2012.

Disappeared

Last Tuesday, Ultrasonic said CEO Wu Qingyong and his son, chief operating officer Wu Minghong, had been missing since the weekend, and most of the company’s cash reserves in China and Hong Kong had vanished. Two days later, the company said the pair had withdrawn the cash in two tranches.

Just five weeks earlier, the CEO and Ultrasonic’s listed holding company had guaranteed the loan from Nomura’s Hong Kong unit after extensive checks on the company and its customers, people involved in the loan talks told Reuters.

CEO Wu was well known in Jinjiang City in the south-eastern province of Fujian, where the company’s factory was located. He received an award from the provincial government last year in recognition of his contribution to the development of the Western Taiwan Straits Economic Zone, according to a government website.

“When people have backgrounds that are shady, you do a lot more thinking about it,” said the first person involved in the talks. “In this case, the gentleman had no such background, and was quite well endorsed by prominent figures in the region. So, he surprised all the banks and investors that bought shares.”

Three people involved in the talks spoke on condition of anonymity. A Nomura spokesman in Hong Kong declined to comment.

Several Taiwanese lenders took part in the loan facility, including Cathay United Bank, which will report the matter to the police, the people told Reuters. No one at Cathay United Bank could be reached on the telephone for comment.

Shadow banking

Ultrasonic did not provide details of the loan agreement, but, a statement last Thursday said creditors had called in the loan the previous day and entered negotiations to determine if insolvency could be avoided.

The company’s predicament comes as investors question the corporate governance of other foreign-listed Chinese firms.

For instance, a US$175m syndicated loan to 21Vianet Group has been “put on hold” because Trinity Research Group has twice challenged the credibility of the Nasdaq-listed company’s financial position. The internet data centre services provider rejects the allegations. (See China Syndicated Loans .)

“Smaller companies are less likely to have reliable financial statements. They’re also more likely to borrow from shadow banking,” said Christine Kuo, senior credit officer at Moody’s Investors Services. “In addition, their businesses are generally more vulnerable during sector downturns.”

Access to funds for small firms could get even more difficult, Kuo said.

Local banks were likely to become increasingly cautious in extending credit, Kuo said, because of an increase in bad loans and because the banking regulator wanted banks to increase reserves, tying up cash that could otherwise be lent out.