China's Anti-Graft Probes Spark a Demand for Risk Consulting Amid Defaults

  • Latest default comes after Yabang chairman involved in probe
  • Firms' bonds and shares tend to sink on executive departures

Chinese President Xi Jinping’s anti-graft drive is fueling demand for risk consulting among investors in the nation’s corporate debt after defaults tied to probes. That’s buoying business for consultancy Kroll.

"If you didn’t do your homework, now you are paying for it," said Violet Ho, senior managing director in Hong Kong for the U.S. firm. More investors are asking for in-depth research, including trying to identify companies’ hidden assets, Ho said. Kroll’s team travels across China to conduct discreet conversations with employees, suppliers and business partners to check firms’ real financial health.

Dye-and-paint maker Yabang Investment Holding Group Co. defaulted on 215.9 million yuan ($33.1 million) in bond principal and interest due Feb. 9 after its chairman’s help in an investigation crimped financing. Future Land Development Holdings Ltd.’s dollar notes plunged by a record last month after its chairman was probed.

Global investors are trying to dodge Chinese debt failures sparked by investigations after Kaisa Group Holdings Ltd. last year became the nation’s first developer to default on dollar notes, amid a probe. China’s harshest corruption battle since the country’s founding in 1949 comes as authorities seek to liberalize financial markets and make them more transparent, in a nation where commerce has for thousands of years been oiled by guanxi -- a term meaning connections or relationships.

Analysts at Schroder Investment Management Ltd. do field trips and surprise visits to borrowers, as well as keeping in touch with management.

“Corporate governance has always been a key point for us when analyzing a company,” said Raymond Chia, the Singapore-based head of credit research for Asia excluding Japan at the money manager with assets of about $446.5 billion under management. "It is even more important in today’s context."

Yabang Investment said in a statement earlier this week that its Chairman Xu Xiaochu had been required to assist in an unspecified probe and some banks had tightened lending to the company after that. Two calls to Yabang’s general line Wednesday went unanswered. A call to Zhang Longxin, the person whose contact appears on the filing, went unanswered.

Market Volatility

Future Land Development said in a Jan. 22 statement that its chairman and controlling shareholder Wang Zhenhua was being probed by authorities in the eastern city of Changzhou. It said the investigation by the Commission of Discipline Inspection of Changzhou’s Wujin district was of a personal nature and unrelated to company activities. Its 10.25 percent 2019 dollar notes plunged by a record 10.3 cents on the next trading day to 98 cents.

The securities have rebounded to 104.4 cents since the firm said on Feb. 10 that Wang had returned to work. Two calls Wednesday to Kenny Chan, executive director and company secretary at Future Land, went unanswered. An operator who answered the firm’s general line declined to transfer the call to relevant departments without a name.

"Now name lending is back," said Ben Sy, the head of fixed income, currencies and commodities at the private banking arm of JPMorgan Chase & Co. in Hong Kong, referring to the practice of giving more consideration to executives’ reputation and not just a firm’s financial health when deciding to extend credit. "You need to look at who the bond issuer is associated with, who their shareholders are and how important those companies are to China’s economy, rather than just looking at their financial statements."

Beyond Financials

Kaisa’s $800 million 8.875 percent 2018 notes fell below 30 cents on the dollar in January last year after the firm said the previous month its founder Kwok Ying Shing resigned for health reasons. People familiar with the matter said in January 2015 that Kaisa was being investigated for links to a former Shenzhen security chief. Kwok returned as chairman in April and neither he nor the company has faced any charges.

Not all probes in China lead to charges or any action by authorities, who in many cases haven’t spoken about the investigations. There have been no accusations of wrongdoing against Yabang or Future Land.

Kaisa’s securities were last trading at about 70.3 cents as it seeks support for a restructuring agreement.

"The recovery in the bond prices reflects that the bond market is positive about our debt," Jiang Xiaodi, an investor relations official at Kaisa, wrote in an e-mailed reply to questions. "Overall our company is proactively working on our offshore debt restructuring and we’re confident about the success of the restructuring."

In China, managers of many companies are often the owners too, so the separation between the two is not always clear, according to Christopher Lee, managing director of corporate ratings for Greater China at Standard & Poor’s in Hong Kong.

“You have to stick to the companies that have strong link to the government or those that play a critical role in the economy because China’s systemic support to state-owned enterprises has always been very strong,” JPMorgan’s Sy said. “You got to be careful dealing with the privately owned companies.”

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