Chinese Investment Firm Gitic Collapses

In one of China’s biggest corporate collapses, the investment arm of Guangdong province declared bankruptcy Sunday, leaving debts of nearly $4.4 billion to mostly foreign lenders, who had believed the government would guarantee the loans.

But in a lesson for both reckless Chinese borrowers and risk-taking foreign lenders, officials said Sunday that there were no guarantees on loans to Guangdong International Trust & Investment Corp., known as Gitic,

Authorities shut down Gitic, China’s second-largest trust and investment company, in October after it missed large debt payments and its management came under investigation.

“Gitic’s board decided to file for bankruptcy because of massive internal and external debt, extremely chaotic management and liabilities that seriously exceeded assets,” said Wu Jiesu, head of the central bank-appointed liquidation committee.

But the move surprised parties on all sides, who had assumed that Gitic, one of China’s best-known borrowers on world capital markets, was too big and well-connected to be allowed to fail.

Gitic’s closure has caused foreign bankers to drastically reduce new lending to Chinese entities and to closely examine loans to other trust companies. But despite the short- term pain, say analysts, the Chinese authorities are doing exactly what international economists have been encouraging it--and other troubled Asian governments--to do: clear out failed institutions instead of bailing them out.

“The closure of Gitic will send the right message out to all parties,” said Fred Hu, executive director of Asian economic research at investment bank Goldman Sachs in Hong Kong. “Foreign banks must be very, very cautious in evaluating credit-worthiness. They can’t think their loans will be guaranteed by the government. For domestic borrowers, it’s a wake-up call: They can’t engage in borrowing sprees and be bailed out by the government. From now on, we should see greater discipline on all sides.”

Gitic representatives told a meeting of about 200 local and foreign investors Sunday that individual Chinese creditors and small investors would be paid back first, in accordance with Chinese law.

One of the thorniest issues to be resolved is the priority for repayment. Despite earlier assurances that foreign creditors would receive priority treatment, trustees said international institutions--including Citibank, Chase Manhattan and Merrill Lynch--must get in line with the rest of the creditors for repayment. The company has assets of $2.6 billion, a spokesman said. It was unclear when or how much of the debt could be repaid.

“There are more or less 25,000 individual Chinese creditors who will be paid first,” Gitic spokesman Wu Xiaohua told reporters. “Foreign creditors will be repaid in accordance with international laws, which means they will not be getting back every cent.”

Gitic has about 240 major creditors, including 135 foreign institutions dominated by Japanese and European banks. Authorities hint that loans that were registered with the government will be dealt with first, and those that bypassed bureaucratic formalities will have to take their chances.

“This will certainly put a chill on future lending to China,” said one U.S. banker.

Gitic and hundreds of other investment companies were set up in the 1980s to help channel foreign financing into the country as Communist China shifted toward a market economy. These “windows” into China were often backed by local governments, making the trust and investment companies, or ITICs, seem as secure as sovereign risk.

Money poured in from international investors eager to ride the country’s strong economic growth and huge infrastructure projects. Gitic officials were known in Hong Kong for their highflying lifestyles, Mercedes-Benzes and personal stashes of cash.

But as China opened up its economy and financiers could invest directly in projects, the ITICs turned to more aggressive gambits to keep the money flowing. Once a model of successful “red capitalism” in Guangdong, China’s wealthiest province, Gitic and its subsidiaries racked up billions of dollars of bad investments in property and stock speculation. Gitic became instead a symbol of the weakness of China’s financial system and Beijing’s fierce resolve to reform it.

“Quite a few of the ITICs have run high financial risks,” said Zhang Lei, an economics professor at Shanghai Finance and Economics University.

“In the past, they didn’t worry about getting into trouble, because the local government acts as a strong backstop to save them and support them.”

But after Premier Zhu Rongji called for a crackdown on financial excesses last fall, it became clear that there were no more blank checks. “Gitic was chosen as a model to others to let them know if they run too high risks, this is what will happen,” Zhang said.

The government concedes that as many as one-third of the country’s 440 state-owned trust companies are insolvent, and that another one-third are losing money. The government plans to consolidate the sector into a few dozen institutions.

Only a handful of the other trust companies have a large amount of foreign debt.

One of them, Fujian ITIC, has a U.S. dollar bond that comes due early next month and is said to have even more debt than its counterpart in Guangdong.

But analysts say Beijing won’t be so quick to shut down another.

“The government doesn’t want to handle two at the same time,” said Andy Xie, Morgan Stanley’s chief economist for greater China.