Shoe Company Cheated Bond Investors: Sources

Regulators suspect a well-known listed Chinese shoemaker of cheating its bond investors, while investors accuse it of illegally transferring funds raised through bond sales to related companies, a Caixin investigation has found.

The investigation has shed light on one type of fraud in China’s $4 trillion corporate bond market, and has revealed the tricks that debt-ridden Fuguiniao Co. Ltd. played behind the scenes, which may have led to its failure to make repayments this year on 2.1 billion yuan ($310 million) in bonds.

Hong Kong-listed Fuguiniao, which manufactures shoes and clothing in the eastern province of Fujian, illegally transferred funds in some cases through one type of financing scheme. One of its subsidiaries would pledge collateral — which regulators suspect was usually money that was originally raised through a bond sale by its parent — to a domestic bank to receive a guarantee letter that it would then present to an overseas lender, in order to persuade that overseas lender to extend a loan to a party related to Fuguiniao.

If Fuguiniao planned to use the proceeds of a bond sale to do this, it legally should have disclosed its plan prior to the sale — which it never did.

This probably led to bond proceeds flowing from the listed company to related parties, such as Fuguiniao’s controller and other shoe and clothing companies based in its home province, damaging the interests of its shareholders, as well as cheating its bond investors, investors told Caixin.

One typical case happened in March 2017 when Fuguiniao’s controller — Fuguiniao Group Ltd. — got a loan from Macau-based Luso International Banking Ltd., after a Fuguiniao subsidiary pledged certificates of 517 million yuan in deposits as collateral to acquire a guarantee letter from Luso’s controller Xiamen International Bank Co. Ltd., the sources told Caixin.

Just one month later, Luso began to urge Fuguiniao Group to make a repayment in advance, saying that the company faced “operational risks,” the sources said. Luso also asked Xiamen International Bank to redeem collateral and use the proceeds to repay the loan on behalf of Fuguiniao Group, which the bank did in July 2017.

This sequence of events repeated itself many times, involving multiple borrowers, most of which are believed to be companies related to Fuguiniao, the sources said.

As of the end of June 2017, Fuguiniao, along with its subsidiaries, had pledged certificates worth nearly 2 billion yuan in deposits, or more than three quarters of its net assets, as collateral for bank loans that went to its related parties, according to its filing (link in Chinese) with the Shanghai Stock Exchange, where its bonds were traded.

That’s basically equivalent to the amount of money it hasn’t repaid to its bond investors. Fuguiniao raised 800 million yuan and 1.6 billion yuan through bond sales in April 2015 and August 2016, respectively, which it ended up defaulting on this year.

Of the nearly 2 billion yuan in pledged collateral, 1.6 billion yuan had been redeemed by July 2017 to repay loans, according to the stock exchange filing.

The filing also mentioned that the local securities watchdog in Fujian issued a warning letter to Fuiguiniao in 2017. The regulator said in the letter that Fuguiniao’s subsidiaries had provided multiple guarantees for loans issued to its related parties from 2014 to 2016, but the company hadn’t disclosed any related information in its bond prospectuses or annual reports.

That’s “fraudulent issuance,” a bond investor told Caixin.

In fact, Fuguiniao’s then-auditor KPMG did spot that the company had concealed its provision of loan guarantees, when auditing its earnings report for the first half of 2016, sources with knowledge of the matter told Caixin. In March 2017, KPMG quit as auditor as the company hadn’t come clean, they said.

Fuguiniao suspended its shares from trading on the Hong Kong bourse in September 2016, as it failed to publish an audited earnings report for the first half of 2016 in a timely manner. It hasn’t resumed trading yet.

This story has been corrected to reflect the source of the allegation that Fuguiniao illegally transferred money raised through bond sales to related parties

Contact reporter Lin Jinbing (jinbinglin@caixin.com)