Caught in China’s cash crunch: why private companies are collapsing into a black hole of shadowy debt

High-profile businessman Zhou Jiancan was last seen at the five-star Shangyu International Hotel on January 30, where he had been countless times before to host conferences and entertain clients in the small city in eastern China.

But on that afternoon, the 55-year-old head of private firm Zhejiang Jindun Holding Group was alone and climbed to a great enough height in the 30-storey building to leap to his death, according to a police report.

Zhou was the embodiment of wealth and success in Shangyu and just days before had been in talks with people from Bangladesh about a multibillion-dollar project to build a coal-fired power plant there, Shangyu Daily reported.

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But his death brought down a house of cards, revealing a mountain of debt and setting off dozens of lawsuits as creditors began chasing their money.

It also revealed the perilous position of private companies, which are denied financing from mainstream banks and often must resort to China’s shadowy world of wealth products to stay afloat.

Zhou’s demise is a dramatic and lurid outcome for what would otherwise be considered the dry and technical policy shift by Beijing to tighten credit as part of its resolve to curb China’s debt, a top priority by Chinese President Xi Jinping.

CREDIT CRUNCH CASUALTY

China’s state banking system largely exists to serve local governments and state-owned enterprises, so private firms must often rely on the “shadow banking” industry – alternative routes of funding that have fed unprivileged private companies because they have restricted access to bank lending – for financing.

But the authorities have started to tighten up on shadow banking, with off-balance-sheet funding plunging by 1.3 trillion yuan (US$190 billion) in the first half of 2018 compared to the rise of 2.5 trillion yuan over same period last year, according to data from the People’s Bank of China.

As a result, private businesses are bearing the brunt. Without credit to roll over debt, some have rushed to pledge their stock shares as collateral for loans and turned to loan sharks for financing – until they couldn’t.

Signs of stress have also become apparent in China’s corporate bond market, where private companies have been encouraged to seek financing. By early June, 20 corporate bond defaults totaling 14.2 billion yuan had occurred, many of them by private, listed firms, according to a report from China Central Depository and Clearing, a state-run settlement service for financial products. Rising default risks have worsened private firms’ bond ratings, pushed up the costs of issuing bonds, and forced some to shrink the scale of issuance.

Tao Dong, Credit Suisse’s economist for private banking in the Asia-Pacific region, described these defaulting private companies battling to get financing as “marginalised”.

“The so-called marginalised company is not necessarily the smallest or with the worst business performance; rather, it’s highly leveraged, increasingly relied upon non-bank financial institutions for funding, and often using short-term funds to finance their long-term investments. These severely indebted firms are usually the first group of victims when credit condition worsens,” Tao wrote.

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State-owned enterprises, on the other hand, can expect bailouts from the state. For instance, China has started a massive debt-to-equity swap for troubled enterprises to cut their debt, and almost all companies covered in such swaps with banks are state-owned. The People’s Bank of China has decided to release 500 billion yuan to the country’s state banks, with the directive to use the money to grease debt-to-equity deals.

AN ENTREPRENEURIAL HOME

The province of Zhejiang is known as a cradle of China’s private business, and a thriving private sector contributes to more than two-thirds of the provincial economy — equivalent to the size of Holland’s. In Zhou’s hometown of Shangyu, which has a population of 770,000 people, there are at least 15 companies listed either on the Shanghai or Shenzhen stock exchanges, China’s main bourses.

Zhou was not as well known as some other Zhejiang merchants, like Li Shufu of carmaker Geely or Zong Qinghou from beverage group Wahaha. But his was a rags-to-riches story seemingly typical of the province, creating a billion-yuan business from a little workshop with only 30,000 yuan in initial investment in 1989.

At the same time, however, Zhou had also accumulated a mountain of debt.

Court papers filed by Zhou’s now insolvent Jindun Group in April show that it had amassed 1.4 billion yuan in debt by the end of 2017. The company had about 1.14 billion yuan in assets, which included cash flow of only 910,000 yuan.

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Separately, Zhou and his son, Zhou Chun, owned the combined largest stake of 26 per cent in Jindun Fans, a company that went public in 2014, where Zhou served as board chairman but was not involved in daily operations.

A public disclosure form filed with the Shenzhen Stock Exchange revealed that the total debt amassed by Zhou and his Jindun Group added up to about 9.8 billion yuan, a third of which came from private creditors or loan sharks, in addition to loans from financial institutions and financing that Zhou secured by pledging all the equities he and his son owned.

Following Zhou’s death in January, trading in Jindun Fans stock was halted; it only resumed on June 1. Since then, the company’s share price has fallen by more than half, from more than 35 yuan per share to about 10 yuan per share on Tuesday .

The specifics about how and why Zhou was so deep in debt remain unclear. In a briefing with reporters two days after Zhou’s suicide, Jindun Fans chief executive Wang Miaogen said that Zhou’s debt crisis started in 2008 – the year when China started a massive fiscal stimulus and spectacular debt build-up – from the creation and expansion of Zhejiang Gross Seamless Steel Tube, a steel pipe firm that cost about 2 billion yuan.

A similar expansion was apparent in the overall Chinese economy, with debt rising from about 140 per cent of GDP in 2008 to 257 per cent in 2017, according to the Bank for International Settlements. That increase accounted for about 40 per cent of the new debt globally in the last decade.

When Jindun’s tubes and other products couldn’t sell quickly enough to generate cash flows to cover the company’s spending, Zhou opted for more debt. According to a report by the Chinese news portal Thepaper.cn, when Chinese banks chose not to lend to Zhou, he turned to loan sharks.

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In his final days, the portal wrote, Zhou accepted loans at interest rates as high as 10 per cent a month, or an annualised interest rate above 120 per cent.

“In one deal, Zhou borrowed 210 million yuan in principal, but he paid 590 million yuan in interest in a little bit more than two years,” according to the report.

The one-year benchmark lending rate in China is set at 4.35 per cent.

In April, a local court ruled that Gross Seamless Steel Tube had to restructure under bankruptcy procedures to try to resolve its debt problem, since its assets were not enough to cover the liabilities. Jindun Group has also filed for bankruptcy.

Jindun Fans declined a interview request from the South China Morning Post, citing outstanding legal issues. Jindun Group didn’t answer phone calls. Zhou’s family declined interview requests.

RUNNING ON EMPTY

On a recent visit to the factory, a complex of drab buildings covering an area larger than 20 soccer fields, there were still signs of production. A sheet recruiting “two male mechanical operators” was pasted outside the compound.

The Jindun Sports Centre, a stone’s throw from the complex, looked abandoned, with muddy and dusty floors, broken basketball and badminton nets, and wires dangling from the ceiling. Video and audio equipment used to stage the company’s annual Lunar New Year staff party also laid deserted.

But there were some signs of activity. A Jindun employee who gave her name as Zhang said she had been working at the company as a quality-control inspector for about seven years. Her job is to sign off on every product for export, the kind of work that she said offered greater employment security than those on the production line.

The sudden death of the company’s boss, though, has cast shadows over the employees’ own prospects.

“I am feeling a bit insecure, but our business operates as normal,” Zhang said. “Some workers definitely have doubts about the future if the company is closed. After all, our families are here. We have to think about where our children go to school.”

“No one can guarantee that your job is safe,” she added. “We are still watching it developing.”

WHEN THE GOVERNMENT INTERVENES 

While Jindun Group’s future may be bleak, another separate but distressed Zhejiang manufacturer has fared better.

Three months after Zhou’s death, signs of trouble emerged at DunAn Group, a separate manufacturing conglomerate about 60km from Jindun and owned by another local entrepreneur. Employing about 29,000 people, DunAn is bigger than Zhou’s Jindun but had similar debt troubles.

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In a letter to the Zhejiang provincial governor in May, seen by the Post and confirmed by the company, DunAn Group, which controls two listed companies, appealed for government support because it was having “liquidity difficulties” as it tried to deal with 45 billion yuan worth of debt.

“If we have defaults, it will have a big impact on financial institutions in Zhejiang province and may trigger systemic risks,” the letter from DunAn said.

The company asked the provincial government to intervene to help solve its debt crisis by convincing financial institutions to keep their loans in place while the company sought to divest. That call for help was answered.

Work continues to tick along at the DunAn precision processing factory in the township of Diankou, where workers make parts for air conditioners. Outside a red banner advertised jobs with a monthly salary of more than 4,000 yuan.

A technical worker at the plant said he had learned from his boss at the end of May that he would get a pay rise for the first time this year, although it would be smaller than the 10 per cent increase from last year.

“I think they want to focus on something that makes profits and throw away those that don’t. Like a sick person, you need to remove bad parts from your body to get healthy,” the worker said.

BIGGER PICTURE

While well known, Zhou was not on any list of China’s richest businessmen; Jindun Group is a medium-sized industrial company. Even so, his suicide has raised debate on Chinese social media about why Chinese private entrepreneurs are having harder times in an economy which officially still grew at a rate of nearly 7 per cent in the first half.

“Had he decided to buy property in Beijing or Shanghai in 2008” instead of setting up a new factory, one online commenter wrote, “he would be a multibillionaire”.

The authorities appear to have taken some note. Beijing has responded to bond defaults and other signs of financial stress by leaning towards monetary easing this year. The fresh headwind of a looming trade war with the United States has also shortened the odds that China will be more dovish in monetary policy so that the pains for China’s private sector can ease.

“I think the Chinese government, after taking all those deleveraging measures in 2017, has realised one thing: leveraging does not cause any crisis. It’s the sudden stop of leveraging that will lead into crisis,” Xu Jianwei, a Hong Kong-based senior economist from Natixis, said.

“Once you cannot borrow more, and banks become more cautious than before, this will make things much worse.”

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Larry Hu, chief China economist at Macquarie Group, agreed.

“What could make things worse is a potential vicious cycle between credit growth and credit risk,” Hu said. “Slower credit growth could increase credit risk, which would further dampen credit growth.”

Back at one of Jindun’s factories in Shangyu, a security guard awaited his fate after six years on the job. Nearing 60, he was counting on the company to continue paying into a social security fund so he could later draw on a retirement pension.

“All I know is they still pay me. Other things, we don’t know,” he said.