With Jail Sentences and Corporate Flameouts, China Is Tackling its Debt

Posted May 10, 2018 6:32 p.m. EDT
Updated May 10, 2018 6:34 p.m. EDT

HONG KONG — A Shanghai court imprisoned a tycoon who used a mountain of debt to buy the Waldorf Astoria hotel. Small Chinese companies are increasingly saying they cannot repay their bills, as money gets more expensive or harder to find. For other private businesses, the cost to borrow has shot up.

Faced with the looming consequences of a decade-long borrowing binge, the Chinese government is intensifying its efforts to stamp out risky lending and speculative froth from the world’s second-largest economy. To do it, Beijing is putting the brakes on shadowy forms of underground lending and making public spectacles of the worst offenders, even as it takes steps to ensure that small investors and the broader economy are not shaken.

The most recent and visible sign came Thursday morning, when a court in Shanghai sentenced Wu Xiaohui, the founder of one of China’s biggest insurance companies, to 18 years in prison. Wu, a former car salesman who rose to become one of China’s most successful businessmen, was charged in March with fraud and accused of using his company, Anbang Insurance Group, to cheat investors out of more than $10 billion.

But other signs are emerging, including loan defaults from a growing number of companies and rising interest rates for many borrowers.

“Like any deleveraging campaign, it is not painless,” said Christopher Lee, a China credit specialist at S&P Global. “There will be losers.”

Wu’s sentence caps a monthslong effort by Beijing to make Anbang an example for other big Chinese conglomerates that borrowed heavily to buy up high-profile trophy assets like hotels and Hollywood studios. Wu was taken into custody last year. Before the Chinese government seized control of Anbang in February, the company had bought the Waldorf Astoria hotel in New York and a string of other marquee properties.

The high-profile deals prompted worries that growing debt was threatening China’s broader economy. Since Wu fell on hard times, the chiefs of other private Chinese companies that borrowed heavily to make splashy overseas deals, like Dalian Wanda and HNA Group, have begun to sell assets to pay down debt.

“The message there is: You guys need to clean up your own mess and sell whatever you can to fix it,” Lee said.

China has also clamped down on its unruly shadow banking sector, a murky area where non-bank lenders connect borrowers with those willing to lend in exchange for big returns — in many cases, small investors are unaware of potential risks. As a result of new government rules, that money is either drying up or also getting more expensive. For example, the cost of raising money through trust loans — a popular form of shadow banking in China — has risen sharply, from 7 percent to as much as 10 percent over the past 12 months, according to Lee.

The impact is beginning to show.

Over the past four days alone, three private Chinese companies have defaulted on debt, telling their bondholders that they cannot make repayments, according to data compiled by S&P Global. So far this year, 13 companies have defaulted on bonds, with the pace quickening in recent weeks. Defaults were rare or nonexistent in earlier years, in part because local authorities pressured lenders to forgive or extend missed payment dates to preserve jobs and keep the economy stable.

“The intensified regulatory control on shadow banking activities have largely shut down this alternative financing channel,” said Ivan Chung, associate managing director of Greater China credit research at the ratings agency Moody’s. “Weak issuers are more vulnerable to default pressure,” he added.

Bankruptcies have shot up, too, with new cases growing by more than half in 2017 compared with the previous year, according to a study by Orient Capital Research. In its report, the research firm said it expected to see a significant increase in defaults by Chinese companies again this year.

Overall borrowing has become more expensive for many companies. Bond rates are rising, too, making it more costly for companies to tap that source of money.

The Chinese government is playing a careful game. Even as it allows more defaults, last month it poured more money into the financial system to contain the potential damage.

It is also sparing larger companies like Anbang. With about 35 million policyholders, Anbang could shake China’s financial system if it collapsed.

“With smaller companies, they are not necessarily going to step in,” said Fraser Howie, a former banker in Asia and a co-writer of three books on the Chinese financial system. He added, “What you’re seeing is that the government is allowing some of them to fail. There are lots of private companies that are defaulting on a daily basis.”

Anbang said Thursday that it had sufficient cash to meet its commitments to customers. Wu, it reiterated, is no longer its chairman. Wu’s lawyer, Zhai Jian, declined to comment. The court found that Wu had illegally sold insurance products to bolster the company’s financial situation. According to the prosecutors, Wu instructed employees to falsify financial statements and marketing information in an attempt to skirt regulations and raise money from the public.

The sentence was a strong one given the charges, said Yan Yiming, a criminal lawyer in Shanghai. The court Thursday also said that it had seized Wu’s bank accounts, real estate and equity.

Wu had initially struck a defiant tone, contesting the charges in March during his only appearance in the court. But facing a potential life sentence, Wu had pleaded guilty to the charges and asked the court to consider a lighter sentence.

“I repent deeply,” Wu said in March in a televised statement from the court. “I know and regret my crimes.”