Editor’s note: This article was originally published in the Yangcheng Evening News. It details the escalating credit crisis in Wenzhou, one of the “boom towns” in Zhejiang Province. In recent weeks, as bankruptcy has become unavoidable for many businesses that have taken on high interest private loans, there has been a wave of business owners who simply ran away. As an effect, these companies go bankrupt, and the entire community, who is heavily invested in the “private lending industry”, loses their investment capital. The end of this article references recent Xinhua reports to give an update on the situation and the government’s efforts to contain the credit crisis.

On September 22nd, many security guards were positioned outside of the Xintai Group's factory in Wenzhou. The previous evening, news had leaked that Hu Fulin, the owner of the Xintai Group, had fled, and it wasn’t long after that various creditors and suppliers started rushing to the factory. Armed with their “mianbao che” (van resembling a loaf of bread) and small trucks, these people came to loot the place. During the next 24 hours, news spread that a total of nine business owners in Wenzhou had fled. According to one analyst, following news that Xintai Group had been unable to pay off its private loans, it was quite likely that other businesses would go bust as well.

From industry leader to bankrupt; what happened?

Two days earlier, on September 20th around 23:00, Hu Mingfen, the CEO of the Xintai Group, had given the Wenzhou Ouhai District Economic Development Zone Board of Management a phone call, where he reported that he suspected that the business’s owner had fled. The next morning, Hu Fulin abruptly called the CEO to tell him that the business’s investment scope had been too ambitious, and that the business was now bankrupt. That same day, the Ouhai District government moved in to handle the incident, setting up various task forces to deal with the (understandably) upset suppliers and creditors, and to register the business’s liabilities and settle the accounts for the staff’s wages.

The Xintai Group was established in 1993, and employed more than 3,000 people. The business was the Ouhai Economic Development Zone’s “leader in the eyeglasses industry”, with the goal to become one of China's top 100 private enterprises. The business’s "Dolphin" brand is the only popular glasses brand produced by a Chinese business. Owner Hu Fulin also dabbled in solar energy, real estate and other industries. The Xintai Group's output value in 2010 was 272 million RMB; January to August this year, it was only 125 million RMB.

Billions in debt, scale of operations too large

How much debt was Hu Fulin’s business in? One netizen allegedly learned from one of the business’s executives that Hu Fulin's real debt amounted to more than 2 billion RMB. Of this, 1.2 billion was from high-interest private loans, with a monthly interest rate as high as 20 million RMB; 800 million was from bank loans, with a monthly interest rate of about 5 million RMB. According to the netizen, the business had become buried in debt that it couldn’t pay off—nearly 900 million RMB.

On September 22nd, government investigators found registered data showing that Hu Fulin had agreed to private loans of 130 million RMB (bank loans had not been discovered at the time). According to the investigator, these registered private loans were certainly only the tip of the iceberg, as Hu Fulin would never have registered the actual amount of private loans; if he had, people would immediately have realised that he would never be able to pay off his loans, his creditors would have caused a ruckus, and the business would have quickly gone bankrupt.

A person familiar with the Wenzhou eyeglasses industry revealed that eyeglasses factories are rarely the size of Xintai Group’s. The average factory would employ 20 or 30 people and would only contract a few companies to supply materials. Profit margins are generally very low in the industry and the payment cycle is about three months. Conversely, the Xintai Group employed 3,000 people, not including the many private creditors and other people working behind the scenes.

Private loans may be high interest, but they are also high risk

There have been frequent news reports on business owners in Wenzhou who fled after private lending led to bankruptcy. In September, a Wenzhou news site and Weibo were circulating a "Wenzhou business owners who will flee soon list". The scope of the involved capital is enormous—tens of millions, hundreds of millions, even billions of Yuan. These high-interest private loan crises continue to intensify, but it is still too soon to tell whether they will affect the entire high-interest private loan industry in Wenzhou.

People in Wenzhou are in an uproar over the trend for owners to flee after their blatant mismanagement and over-reliance on high-interest private loans backfires. Companies with this business model are referred to as “Guarantee Companies”. The Guarantee Company's capital isn’t its own; instead capital comes from private lending. That private lending capital comes from common households that have given their money to a middleman to loan to a company in return for a high interest return. Consequently, when the owner of the Guarantee Company flees, hundreds of thousands of ordinary households will lose everything they “invested”.

This industry is very common in Wenzhou. The central branch of The People's Bank in Wenzhou recently published the "Wenzhou private lending market report", which showed that the private lending market in Wenzhou is extremely active – 89% of households and 59.67% of local businesses participate in private lending. Currently, the amount of private lending in Wenzhou is more than 110 billion RMB.

Why do people get involved in private loans?

Zhou Dewen, the president of Wenzhou's small and medium sized enterprise development association notes that the capital from the number of institutions and individuals that are engaging in private lending activities has been snowballing. In recent years, foreign investment in Wenzhou has also increased, and following the financial crisis, the Shanxi coal issues, the crisis in Dubai, the purchasing limitations in the housing market, stocks prices slumping etc., money has continued to flow back into Wenzhou, where people tempted by promises of high interest returns, have gotten involved in the private lending market.  

According to Zhou Dewen, the current interest rate level of private lending in Wenzhou is already the highest in history; in general, the monthly interest rate is 2-6%, some even reaching upwards of 10% or 15%, and the annual interest rate is 180%. For the majority of small and medium sized enterprises doing business in Wenzhou, their gross margin doesn’t exceed 10%, and is generally around 3-5%, so accepting these high interest loans will likely lead businesses into a dead end.

After the global financial crisis, China recently imposed new measures for its banks to clamp down on sub-prime loans (loans given to companies deemed “high risk”). As a result, businesses are having more difficulty securing bank loans, which has led them to seek less-ideal options, such as the now prospering high-interest private loans market. According to Yi Xianrong, a researcher at the Financial Research Institute at the Chinese Academy of Social Sciences, academics had already cautioned the government about the negative consequences of tightening credit, but these warnings were largely ignored.

The government steps in

In the wake of this local credit crisis, Chinese Premier Wen Jiabao visited Wenzhou on October 4th to urge the local authorities to take action to help the local businesses. Following Wen Jiabao’s visit, the local and provincial governments introduced a series of measures to hopefully contain the crisis and prevent it from becoming a national crisis. A 100 billion RMB bailout plan has been set up to help indebted owners repay high-interest loans taken out with the private lenders. The local government has also worked behind the scenes to persuade banks and creditors to be more sympathetic to these businesses, and set up teams to help businesses restructure themselves and get out of debt. Time will tell if these measures will be effective.
 

Source: ifeng
 

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Keywords: Chinese businesses private lending Wenzhou credit crisis business mismanagement in China Wenzhou private lending business owners fleeing China