Lingering Issues for Huludao Loan Dodgers

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After an investigation that lasted nearly a year, the notorious Huludao loan case – in which a bank and a private business colluded to dodge debt payments – has been officially settled.

But questions remain about the depth of the bad debt at the Agricultural Bank of China (ABC) branch in Huludao, a city in Liaoning Province, as well as lending practices at other banks in the region.

ABC in late May penalized 15 staffers at the Huludao branch who were implicated in the case, which came to light after ABC launched an internal audit last year.

Meanwhile, authorities in May hauled away Zhao Baojie, founder of a private construction business called Zhida Group that took out a loan for more than 850 million yuan in summer 2008 with help from the Huludao staffers. Formal charges against Zhao have yet to be announced.

ABC's audit angered some senior central government finance officials. But the Huludao bank was on a list of ABC branches picked by the central government's National Audit Office for close examination. The China Banking Regulatory Commission also got involved.

The audit office confirmed Zhida's problematic loans and reported the case to the State Council. Although only a relatively small amount of cash was involved, senior officials decided it set a bad example, called for a thorough investigation, and ordered severe penalties.

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But the Huludao branch's prospects for recovering its loans to Zhida are dim. Meanwhile, other local enterprises are dodging debts tied to the case, blaming the global financial crisis.

Debt Dodging

Zhida Group borrowed up to 858 million yuan, accounting for 17 percent of the Huludao branch's 5 billion yuan in loans in 2007, according to ABC's audit. Between June 2006 and early 2007, Zhida's loan from the Lianshan sub-branch of the Huludao branch increased from 380 million yuan to 850 million yuan.

Zhida got away with such huge loans by borrowing in small packages through subsidiaries and affiliates. Another trick was to dump debt through phony accounts and guarantees. Zhida transferred debt to new companies that would be unable to make good, eventually rendering all loans to Zhida non-performing for ABC.

Certain staffers acted as contacts between Zhida and the bank, a source said. They "reported to Zhida every step taken by ABC headquarters and its provincial bank, and passed on information about how the bank plans to dispose of Zhida's corporate assets."

Meanwhile, the bank formed a special team to work at recovering NPLs. Its members including 15 staffers who had been laid off from the Huludao branch and Lianshan sub-branch after they worked with bank customer Zhida.

Zhida assured the team that the company was actively trying to sort out issues. But the loan recovery process moved slowly.

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Now, collecting debt remains a thorny issue because Zhida's scam included transferring debt to subsidiaries, which allowed the company's overall credit line to rise.

For example, subsidiary Tianhong Trade Co. took over 78 million yuan in "normal" Zhida loans through four transactions in March 2007. Tianhong stopped paying interest on the loans nine months later, and fell 2.5 million yuan behind in payments as of February 2008.

That same month, the bank labeled the loan "attentive" and, a week later, stamped it "doubtful." Even after the loan was downgraded to "doubtful," Lianshan sub-branch bank officials failed to press Zhida for payment.

The audit said Zhida's subsidiary spin-offs made it possible for the company "to retain valid assets and get itself out of heavy debt."Moreover, bankers were hard-pressed to follow the trail of debt transactions and determine Zhida's assets.

During the probe, Zhida's top executive Zhao busily transferred assets. Sources close to Zhao said his personal savings amounted to only about 100,000 yuan when investigators knocked on his door. No one knows where the rest of the money went.

An official at ABC's Liaoning provincial office who asked to remain anonymous said Zhida's cash flow nearly dried up during the investigation, and most of its real estate development projects were left unfinished. (See Caijing's October 2008 story at http://english.caijing.com.cn/2008-10-06/110017609.html.)

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Outstanding Issues

But the Huludao bank branch faces other critical issues, including a skyrocketing NPL ratio. Facing a lack of credit alternatives, many enterprises have failed to pay bank loan interest and eventually default.

This trend has been linked to a new loan policy implemented locally before China's 2005 shareholder reform. The policy says borrowers cannot get new loans before paying old debts, leaving many bank loan-dependent private enterprises starved of cash.

Many private entrepreneurs started worrying when they saw the walls closing in on Zhida. So they started transferring assets, pushing the Huludao bank's NPL ratio higher.

Some have tried to explain away the bank's high NPL ratio as "a product of the financial crisis" linked to "enterprise excessive expansion, long-term investment on short-term loans, over-borrowing, slumping business operations and a tight capital chain."

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Sources told Caijing most of the bank's loans went to private enterprises like Zhida.

And bad debt is only one of ABC's problems in Huludao. Another issue is that the group of 15 disciplined staffers does not account for others who may be accountable.

A veteran employee at the Huludao branch said a personnel problem is acute as well: Area bank staff members are entrenched, and none have recruited new staffers for more than 10 years. At one large local bank, most workers are in their 50s and none of the recent hires were under age 35.

"Only with personnel reform and overall renewal can the banks be revived," the bank worker said.