Rich pickings for loan guarantors, but at a price
The stock market is all about themes. As the mining concept loses steam after several years, a mainland 'para-financial' theme is kicking in.
It's about the tens of millions of private entrepreneurs whose small to medium-sized businesses have had little luck in getting loans from commercial banks. It's about the loan guarantors who promise to get them loans from banks. It's about trust companies that sell the newly rich all kinds of trust products and then loan the money out to those in need.
This can be big business and investors love it. (So do stock commentators in the Chinese press who need new themes to talk about.)
In August, Jingwei Textile Machinery bought control of Zhongrong International Trust Company for 1.2 billion yuan (HK$1.4 billion).
The new business turned Jingwei into a profit-making company. Its stock has gained 126 per cent since then.
In December, a shell company, which had changed its name to China Financial International Investment only months ago, said it is investing in several mainland loan guarantors, which specialise in lending to small firms.
China Financial has spent 36 million yuan for a 30 per cent stake in a privately owned guarantor in Jiangxi. It is also in talks with two state-owned guarantors in Jiangxi and Wuhan to make equity purchases in them. China Financial's stock has gained 35 per cent since.
Last Monday, another shell company, Paradise Entertainment, announced it was negotiating to buy 25.73 per cent of the Chongqing International Trust, the largest in the region. While the Hang Seng Index has dropped 5.4 per cent, its stock has gained 4.6 per cent.
There will be more to come.
'My desk used to be full of mining proposals. Now there is a handful of para-financials looking for investment or listing,' said a banker.
The fact is, every non-bank financial institution has seen both growth as well as risk increase in the past few years thanks to Beijing's economic stimulus measures and its policy of encouraging the financing of small and medium-sized businesses.
In 2009, the average assets of trust companies in the country reached 40 billion yuan, which is 50 times their capital. That same year, the number of loan guarantors grew by 30 per cent, according to official figures.
As Beijing starts its cooling measures, regulators begin to tighten their grip. New rules released in March say loan guarantors can guarantee no more than 10 times their equity. Another regulation in October says a trust firm's equity should equal its risk-weighted assets.
All of a sudden, almost every para-financial is looking for money to beef up its ratio. But they are not allowed by law to take deposits. Selling shares is the only way.
So how good are these businesses? I am no specialist but there are plenty of telling anecdotes. As always, they are not in the announcements made by the buyers.
What Paradise did not tell is the public probe by the Chongqing State Asset Supervision and Administration Office against the executive director and chief executive of Chongqing International Trust (CIT),Weng Zhenjie.
According to documents read publicly in the Chongqing legislature, Weng allegedly financed triad-related loan sharks with about 200 million yuan of CIT's money and solicited a 1.35 million yuan bribe in return for a 350 million yuan loan.
A Chongqing legislator and disgruntled business partner, Zhang Mingyu, read out the allegations and produced more than 100 pages of documents for the legislature. Shortly afterwards, his office, where many of the documents were housed, caught fire. He told reporters he was in great danger and disappeared.
Weng denied the allegations. An official of the state asset supervision office said an investigation was under way.
What Jingwei did not reveal in its announcement is that it has to pump a fortune into Zhongrong to bring its equity level in line with regulatory requirements.
Zhongrong's equity to risk-weighted asset ratio is estimated to be 28.5 per cent, or a quarter of the 100 per cent requirement, before Jingwei took control. Zhongrong needed an additional 1.4 billion yuan.
Jingwei and other shareholders have to forgo two dividend payments to beef up Zhongrong's equity. Still, it has yet to meet the required level and has to stop growing its business.
As for China Financial's investment in loan guarantors, an unrelated feud at Credit Orienwise can offer a cautionary tale. Orienwise was the first joint-venture guarantor in the country and it's a big one, with a capital base of 3.2 billion yuan.
Orienwise's foreign shareholders - Citibank Venture, Carlyle, Asia Development Bank and General Electric - have recently filed a lawsuit in Hong Kong against Orienwise's mainland chairman, Zhang Kaiyong, alleging financial fraud and demanding details of his personal properties. The company issued a press release on the matter late last year.
Zhang denied any wrongdoing.
The company issued another statement in October revealing that 'the former general manager of a China subsidiary has suddenly resigned and his whereabouts was unknown'. The statement went on to say that it was suspected that he had used the company seal in an unauthorised way and 'illegally granted guarantees to secure loans of substantial amount'.
In the meantime, the nation's 5,547 loan guarantors made a total profit of 4.45 billion yuan in 2009, according to the country's bank regulator. That is an average of 800,000 yuan per guarantor. How does that sound?