Slippery Future for a Slick Loan Guarantor

飞雪寒冰

Despite a recent wave of government policy support for China's loan guarantee industry, the country's so-called flagship guarantor Credit Orienwise Group Co. Ltd. (COGC) is barely treading water.

These days, COGC's main office in downtown Beijing is half-empty, and disgruntled clients are standing at the doors. Employees say it's the same story at the company's headquarters in Shenzhen.

COGC managed to satisfy most of its unhappy investors and debt holders after posting an unexpected 1.2 billion yuan loss last year and surviving a foreign shareholder revolt in September. But the company's reputation has taken a serious hit.

In recent months, employees and clients of COGC subsidiaries have fled en masse, while the company's relations with banks have faltered. The statistics that COGC shares with banks show that its loan guarantee business is in rapid decline.

And lined up at COGC's office in Beijing, Caijing found plenty of angry customers, including small and medium-sized company representatives whose loan contracts were not honored. Customers said they had repaid their loans but were now being forced to wait for COGC to return their cash deposits.

Meanwhile, company chairman and founder Zhang Kaiyong has been frantically trying to save his company.

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In one of Zhang's moves, COGC early this year reached a debt-equity swap agreement with foreign bondholders. The deal called for diluting Zhang's stake in the company to 32.26 percent from a controlling 53.76 percent. Bondholders and foreign investors together would hold approximately 65 percent.

The rescue operation also included a five-city road show from May to July by COGC executives, who tried to convince investors that they have made significant improvements to shareholder structure, reporting, corporate governance and internal controls. They also hoped to drum up new cooperation deals with banks.

And in June, Zhang took another salvage step by selling the Zhangjiajie Landscape Hotel, which had been held by his personal company China Orienwise Holding. Cash from the sale may be used to prop up Credit Orienwise.

On June 18, the company got some good news when it was announced at an internal meeting that it had secured support from China Development Bank, a government policy bank.

Nevertheless, COGC is still hanging by a thread. Foreign shareholders and bondholders think the rescue plan won't work; they're pushing for a restructuring.

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Big Start

COGC opened in 1999 in Shenzhen as China's first and largest privately held, commercial loan guarantee agency. According to public information, its capital base grew to 3 billion yuan from a startup level of 50 million yuan.

Today, COGC is the best known brand among China's loan backers. It has 17 guarantee companies in 11 cities and the banking system's largest sum of guaranteed loans.

COGC data filed with the National Federation of Industry and Commerce last November boasted of cooperation with 31 Chinese and foreign banks involving more than 900 enterprises, and accumulated guarantees of more than 74 billion yuan.

Until recently, Zhang was always in control of the company. He is a 48-year-old Hubei Province native who in 2008 ranked 14th on the Finance Rich List of Hurun Report based on personal assets of 2.2 billion yuan.

Four foreign shareholders –Asian Development Bank, Citigroup Venture Investment Corp., Carlyle Group and General Electric Finance –bought stakes in COGC starting in 2005. Their combined investment of US$ 110 million equals 40.82 percent of the company.

COGC also raised money in November 2006 by issuing bonds worth US$ 100 million on the Singapore Stock Exchange, offering an annual interest of 10.5 percent over five years. Eleven fund management companies from Belgium, Britain, the United States, Singapore, Hong Kong and other areas subscribed.

But by 2008, COGC's performance had declined precipitously, and the company had to axe plans for a Hong Kong stock listing.

In a report to the Singapore exchange, the company said it posted a 1.22 billion yuan loss in the first half 2008, compared to a 152 million yuan profit in 2007.

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Blog Outing

A series of blog entries posted on Chinese portals in May described how a former COGC employee exposed what he called the company's "original sin." The entries said COGC's capital, after verification, was always removed.

Critics claimed most of the company's reported 3.2 billion yuan in total capital had been fabricated, except for only US$ 210 million in hard cash from foreign share and bond holders.

"Funds from various companies never once made it to the real account," a former COGC executive told Caijing.

COGC's guarantee business is basically a loan examination outsourcing service for small enterprises. The guarantor uses its capital, credit and professional credit checking standards to back small- and medium-sized enterprises that want bank loans. The guarantor collects a cash deposit and a guarantee fee from each enterprise.

When an SME loan goes bad, COGC's capital scale determines whether it is capable to repay the loan for its clients. In the same way that Chinese banks strive for an 8 percent capital adequacy ratio, the guarantee industry currently says guaranteed loans' leverage ration cannot exceed 10 times.

It means that at least 10 percent of COGC's loan guarantees should be held in cash. This restriction basically guaranteed the guarantor could manage the risk of loan defaults.

The blog author, told Caijing COGC inflated its cash position and corresponding profits to attract foreign shareholders. After foreign investors bought in, the company came under pressure to keep the good times rolling – at least on paper.

The losses finally came to light in mid-2008, revealing a gaping hole in the company's cash position. In addition, the company had been misappropriating customer loan guarantee deposits -- and foreign shareholders' capital – for several years by directing the cash into off-the-books investments.

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Foreign Attraction

COGC started pushing for foreign investment in 2001 when a company called the Inter-American Investment Bank put up US$ 3 million for a 9.55 percent stake. A year later, a Hong Kong firm called Rand Corp. paid US$ 5 million for a 15.9 percent stake. Insiders were suspicious about these little-known, so-called "foreign" investors.

The Asian Development Bank became the first well-known investor in May 2005, contributing US$ 10 million. At the time, global investors were flush with liquidity and searching for places to park capital. COGC seemed a prime target with its background in the Chinese loan guarantee industry and a firm endorsement from the Asian Development Bank.

Citigroup Venture invested US$ 25 million in October 2005, and the following March the U.S. private equity fund Carlyle Group matched that amount. GE Capital jumped into the game with US$ 50 million in October 2007.

These foreign investors hoped to turn COGC into a world-class loan guarantee brand and launch an overseas listing. Some investment banks thought COGC's post-listing market capitalization could reach US$ 4 billion. COGC's business plan said that, in five to 10 years, the company would set up subsidiaries in the world's major cities and guarantee loans of up to 100 billion yuan.

With capital in hand, COGC set about establishing offices in a number of major cities worldwide. By the end of 2007, net assets had reached 3.2 billion yuan.

But the rapid expansion posed a serious challenge to COGC's laissez-faire management style. Most subsidiaries were independent legal entities that fought for a chance to carry the COGC flag to the top of the hill. But these subsidiaries grappled with varying conditions for development, as well as different revenue and income levels. Because of these inherent weaknesses, the group had to remove subsidiaries' assets and transfer customer down payments to whitewash financial reports. The process pitted subsidiary executives against each other.

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Internal Strife

In May 2007, Zhang called executives from domestic and foreign offices together for what was supposed to be a secret meeting. One meeting participant said then-financial controller Wang Qiong revealed some alarming data.

COGC's 2006 profit had totaled 37.4 million yuan on revenues of 190 million yuan, Wang announced. But he also said the company had lost money in 2003, '04 and '05. His report clashed with information from external audits that showed respective profits of 80.7 million yuan, 73 million yuan and 140 million yuan for those years.

This meant that, by the end of 2006, COGC had made fake profit of 580 million yuan, inflated assets by  1.1 billion yuan.

The blog entries offered what the author claimed were direct quotes from Zhang at the meeting.

"For some time now, the company has not been making money," Zhang allegedly said. "In order to draw in strategic investors and go public, it was necessary to make fake profits and revenue, and the resulting hole became ever larger.

"There are seven pots and only two lids," he was quoted as saying. "How to cover the truth has always weighed heavy on my heart. I can no longer bear the weight."

Also at the meeting, Zhang apparently announced that executives could choose to leave the company or "help each other and charge toward the future." The "help" supposedly included efforts to conceal genuine financial performance data and find ways to hide the truth from company auditors at Deloitte.

After "uniting" the thinking of COGC executives, a special business meeting was convened in May 2007. The subject: How to "perfect" the phony commissioned loan business (internally called "group business") in order to pass the audit.

The commissioned loan business consisted of high-interest, short-term loans to cash-strapped enterprises willing to pay a 21.6 percent rate. This chunk of assets and corresponding income accounted for nearly half of COGC's publicly reported data – more than 1.7 billion yuan by mid-2008.

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Meeting records obtained by Caijing from a COGC executive show Deloitte auditors were suspicious of the commissioned loan business, mainly because of its massive size. They also determined its business files and processes were too simple, and that there were gaps in data and discrepancies in the registered addresses of customers.

In fact, a considerable number of commissioned loans were merely transferred internal funds. Over and again, the company's "left hand loaned to the right" to inflate the business and asset scales. Creditors were often simply shell companies with few assets.

COGC's model of phony expansion to attract capital eventually collapsed.

Strife among executives and employees followed Zhang's decision to buy back employee shares at a discount after selling some of his old shares – equal to an 8 percent stake – to GE Capital. Zhang acknowledged in an interview with Caijing last December that his move had sparked conflict.

But trouble started brewing even earlier -- in July 2008 – when a former COGC executive leaked details of the company's financial report fabrications to several foreign shareholders.

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Hard Landing

COGC executives convened another emergency meeting in late July 2008 to discuss the whistle-blower's letter. The writer claimed COGC had accumulated losses of 700 million to 800 million yuan over the years, and that its financial results had been consistently fabricated.

Shell companies were used to create a phony commissioned loan business which, the author wrote, involved more than 1 billion yuan at its peak. And this false business hid the fact that COGC had actually lost hundreds of millions of yuan every year, and had paid out more than 100 million yuan in repayment for customers.

The letter also stated that, by transferring funds raised from bond sales to the commissioned loans business, funds had been freed up for share purchasing in a placement by Shenzhen Ping An Insurance, and afterwards mortgaged to banks for cash.

Caijing also learned that Zhang admitted to fellow executives that most the letter's accusations were true. Surprisingly, he seemed relieved.

"Before, I felt like I was holding in a secret, like there was a millstone around my neck, making it hard to walk forward," he said. "I thought no one knew anything, but in fact they (foreign shareholders) aren't stupid."

Subsequently, in its 2008 interim report, COGC announced a 1.4 billion yuan provision as a result of the huge losses in its commissioned loan business.

Explaining the dramatic nosedive, Zhang said deteriorating economic trends had seriously hurt SME clients. Deloitte, saying it was "unable to make judgment".

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Confusion and a lack of transparency also tainted the accounts of Zhang's private Orienwise Holdings and COGC, further raising suspicions of misappropriation among foreign shareholders and employees.

Apparently, COGC's loan guarantee fund-raising platform had for years been used to provide a steady supply of funds for Orienwise Holdings. Zhang told Caijing that Orienwise Holdings had registered capital of 200 million yuan and 700 million yuan in liabilities. "The largest contributions to profits came from financial investments and real estate," he said.

Public documents show that, as of the end of 2007, Orienwise Holdings had operating income of 2 billion yuan, net assets of 3.5 billion yuan, and total assets of about 4 billion yuan.

A former COGC executive said Orienwise Holdings had seven or eight financial equity investments, including partial equity rights in Xiamen Commercial Bank and Guotai Jun'an, and 14 million shares in Ping An Insurance.

In addition, Zhang's private company controlled Shenzhen City China Orienwise Trade Development Co., Shenzhen City China Orienwise Asset Management Co., Zhangjiajie Landscape Ltd., the Zhangjiajie Gen Li International Hotel, and other properties.

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Mutual Aid

COGC was heading for a hard landing when Zhang, along with the company's foreign shareholders and creditors, started scrambling to protect one another.

As soon as the non-commercial Asian Development Bank learned of the dishonest behavior, its investment was withdrawn. Contacted by Caijing, a bank spokesman would say only "relevant legal proceedings are still in process."

COGC convened a "latest information report meeting" last March, telling creditors holding bonds worth US$ 100 million about a plan for a debt-equity swap agreement. Creditors were told they could become COGC's largest shareholder, with a combined 40 percent stake, diluting Zhang's holdings to 32.26 percent. Meanwhile, the four foreign shareholders would have their holdings diluted to a combined 24.49 percent.

The agreement signaled a transfer of control. Creditors could appoint five future directors, while Zhang would be able to appoint only three. Creditors also would have the right to name the company's financial controller, risk management controller and chief restructuring officer at the group's headquarters.

As for how to make up for the capital gap, the solution called for COGC to claim receivables of 1.2 billion yuan from a Shenzhen-based property agent company which is a subsidiary of Zhang's Orienwise Holdings.