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Fall of China’s ‘most profitable’ coal miner is a cautionary tale



Less than a decade ago, Yongcheng Coal and Electricity Holding was one of China’s most celebrated energy companies.

Blessed with ample reserves of high-grade coal at its mines in China’s central Henan province, the nation’s government-controlled banks were eager to hand the firm cheap credit. At its height in 2013, the business’s annual revenue was Rmb127.4bn ($19.5bn).

“We were the most profitable coal mine with the highest salaries in the nation,” said one senior Yongcheng executive, who asked not to be identified, of that period.

A dramatic decline has changed all that. The city of Yongcheng, where the group is based, is today pockmarked with half-built and dilapidated buildings. Struggling workers at the company, many of whom have not been paid for months, have taken to packing and selling flour to make ends meet.

But Yongcheng’s woes did not take on national significance until last month, when the company defaulted on bonds worth Rmb3bn.

That development disturbed China’s $15tn public debt market, the world’s second-biggest, and kicked off a spate of defaults at other local government-controlled businesses, which account for a big chunk of the country’s economy.

The defaults have ricocheted through China’s financial system. Analysts say that state-linked companies now face difficulties raising capital as a result. The episode has also obliterated longstanding investor assumptions that authorities will always bail out state-owned enterprises in China.

“The biggest impact has been on other state-owned issuers,” said Chen Long at Plenum, a Beijing-based consultancy. “SOEs from Henan haven’t been able to issue any bonds in the last few weeks. The longer that their companies are not able to issue bonds, the bigger the problem will grow.”

Some think that Yongcheng’s difficulties could be a harbinger for problems at other state-linked groups across China. “Yongcheng’s business failure could happen to any state-owned enterprise with weak fundamentals,” added a Beijing-based investor that bought the company’s bonds. “A lot more defaults could be in the pipeline.”

In the case of Yongcheng, the group’s downfall was sown by the financial unravelling of its parent company, Henan Energy and Chemical Group. HECG forced the coal miner to issue increasingly pricier bonds and borrow from China’s less regulated shadow bank sector at a time when the overall credit environment was tightening.

That transformed Yongcheng from what its bankers regarded as a low-risk borrower into a much riskier proposition with a myriad of creditors.

The woes for Yongcheng and its parent can be traced back to more than a decade ago when the latter launched an ill-fated expansion into coal-derived chemicals.

Line chart of Yields on triple-A rated bonds in China (%) showing Chinese bond yields jump after spate of defaults

The venture earned HECG a spot on 2011’s Fortune 500 list of the world’s biggest companies, prompting the Henan provincial government to call a press conference to celebrate the milestone.

HECG aimed to become “a world class coal company”, Chen Xiang’en, the group’s president at the time, said of its pivot to high-end chemical products, which would eventually cause heavy losses for the company.

Prices of ethylene glycol, one of HECG’s biggest chemical products, have fallen by almost two-thirds since the group began manufacturing it in 2011 because of a supply glut, with little respite on the horizon. “China’s coal chemical industry is facing an oversupply that could take many years to ease,” said Qi Dan, an analyst at Baiinfo, a consultancy.

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As its troubles in the chemical market deepened, HECG struggled to service its bank loans. As a result, it turned to China’s nascent bond market, where it has raised Rmb60bn ($9.1bn) over the past five years, according to public records.

“We paid a price for expanding our footprint without taking into account profitability,” said one senior manager at HECG.

In an attempt to shore up its finances, HECG began pressing Yongcheng, its best-performing subsidiary, to tap bond markets. Yongcheng has raised Rmb66bn in debt since 2018, typically paying investors interest of about 6 per cent.

But Yongcheng also turned to more expensive trust loans — off-balance sheet lending by banks and other financial institutions — with interest rates ranging between 6.5 and 7.5 per cent. According to people directly familiar with Yongcheng’s fundraising activities, a significant portion of its bond and trust loan proceeds were used to pay off HECG’s debts.

Yongcheng was not forthcoming with its investors about this, often telling them that it was raising cash to replenish working capital or pay down its own debt. China’s National Association of Financial Market Institutional Investors, a regulatory body, last month accused four of Yongcheng’s bond underwriters, its auditor, a rating agency and HECG of breaking capital market rules. Yongcheng and HECG declined to comment.

Bar chart of  showing China’s domestic debt market by issuer

Some Yongcheng creditors say they knew the miner was propping up HECG, but assumed Henan’s provincial government would stand behind both companies because of their strategic importance to the local economy, which thrives on exports of coal and flour. But they did not anticipate the Covid-19 pandemic, which has slammed many regional governments’ finances.

“We knew HECG was dragging Yongcheng down,” said one investor. “But HECG is the biggest SOE in Henan and the provincial government can’t afford to let it go under.”

Hopes of a full bailout from Henan are fading as the provincial government struggles with its own growing fiscal deficit.

Two Yongcheng bondholders told the Financial Times that HECG assured them early in November that the local government would inject Rmb15bn into the group to resolve its debt problem. But less than half of that sum has arrived, according to people with direct knowledge of the situation. “We maintained faith in government backing until the last moment” before the default, one of the investors said.

Since Yongcheng’s default, more than 260 SOEs have suspended bond issues. Those that have gone ahead are having to pay higher interest rates.

“Now that government guarantees are gone, underperforming SOEs must pay higher interest or they won’t gain access to the credit markets,” said the head of credit ratings at a Beijing-based bond investor.

For many employees who are enduring hardship as a result of the company’s difficulties, Yongcheng’s fall has been a humbling experience.

“Ten years ago I could earn Rmb12,000 a month when my friends at other companies made less than Rmb2,000,” said one Yongcheng engineer who has been with the company for 15 years, but has not been paid for six months.

He is now selling flour to sustain a living. “Now I must live without a salary for half a year and there is no update on when my next pay cheque will arrive.”

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US regulators launch crackdown on Chinese listings




US financial regulation updates

China-based companies will have to disclose more about their structure and contacts with the Chinese government before listing in the US, the Securities and Exchange Commission said on Friday.

Gary Gensler, the chair of the US corporate and markets regulator, has asked staff to ensure greater transparency from Chinese companies following the controversy surrounding the public offering by the Chinese ride-hailing group Didi Chuxing.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” Gensler said in a statement.

He added: “I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies.”

The SEC’s new rules were triggered by Beijing’s announcement earlier this month that it would tighten restrictions on overseas listings, including stricter rules on what happens to the data held by those companies.

The Chinese internet regulator specifically accused Didi, which had raised $4bn with a New York flotation just days earlier, of violating personal data laws, and ordered for its app to be removed from the Chinese app store.

Beijing’s crackdown spooked US investors, sending the company’s shares tumbling almost 50 per cent in recent weeks. They have rallied slightly in the past week, however, jumping 15 per cent in the past two days based on reports that the company is considering going private again just weeks after listing.

The controversy has prompted questions over whether Didi had told investors enough either about the regulatory risks it faced in China, and specifically about its frequent contacts with Chinese regulators in the run-up to the New York offering.

Several US law firms have now filed class action lawsuits against the company on behalf of shareholders, while two members of the Senate banking committee have called for the SEC to investigate the company.

The SEC has not said whether it is undertaking an investigation or intends to do so. However, its new rules unveiled on Friday would require companies to be clearer about the way in which their offerings are structured. Many China-based companies, including Didi, avoid Chinese restrictions on foreign listings by selling their shares via an offshore shell company.

Gensler said on Friday such companies should clearly distinguish what the shell company does from what the China-based operating company does, as well as the exact financial relationship between the two.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” he said.

He added that companies should say whether they had received or were denied permission from Chinese authorities to list in the US, including whether any initial approval had then be rescinded.

And they will also have to spell out that they could be delisted if they do not allow the US Public Companies Accounting Oversight Board to inspect their accountants three years after listing.

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Wall Street stocks climb as traders look past weak growth data




Equities updates

Stocks on Wall Street rose on Thursday despite weaker than expected US growth data that cemented expectations that the Federal Reserve would maintain its pandemic-era stimulus that has supported financial markets for a year and a half.

The moves followed data showing US gross domestic product grew at an annualised rate of 6.5 per cent in the second quarter, missing the 8.5 per cent rise expected by economists polled by Reuters.

The S&P 500, the blue-chip US share index, closed 0.4 per cent higher after hitting a high on Monday. The tech-heavy Nasdaq Composite index climbed 0.1 per cent, rebounding slightly after notching its worst day in two and a half months earlier in the week.

The dollar index, which measures the US currency against those of peers, fell 0.4 per cent to its weakest level since late June after the GDP numbers.

“Sentiment about the economy has become less optimistic, but that is good for equities, strangely enough,” said Nadège Dufossé, head of cross-asset strategy at fund manager Candriam. “It makes central banks less likely to withdraw support.”

Jay Powell, the Fed chair, said on Wednesday that despite “progress” towards the bank’s goals of full employment and 2 per cent average inflation, there was more “ground to cover” ahead of any tapering of its vast bond-buying programme.

“Last night’s [announcement] was pretty unambiguously hawkish,” said Blake Gwinn, rates strategist at RBC, adding that Powell’s upbeat tone on labour market figures signalled that the Fed could begin tapering its $120bn a month of debt purchases as early as the end of this year.

The yield on the 10-year US Treasury bond, which moves inversely to its price, traded flat at 1.26 per cent.

Line chart of Stoxx Europe 600 index showing European stocks close at another record high

Looking beyond the headline GDP number, some analysts said the health of the US economy was stronger than it first appeared.

Growth numbers below the surface showed that consumer spending had surged, “while the negatives in the report were from inventory drawdown, presumably from supply shortages”, said Matt Peron, director of research and portfolio manager at Janus Henderson Investors.

“This implies that the economy, and hence earnings which have also been very strong so far for Q2, will continue for some time,” he added. “The economy is back above pre-pandemic levels, and earnings are sure to follow, which should continue to support equity prices.”

Those upbeat earnings helped propel European stocks to another high on Thursday, with results from Switzerland-based chipmaker STMicroelectronics and the French manufacturer Société Bic helping lift bourses.

The region-wide Stoxx Europe 600 benchmark closed up 0.5 per cent to a new record, while London’s FTSE 100 gained 0.9 per cent and Frankfurt’s Xetra Dax ended the session 0.5 per cent higher.

In Asia, market sentiment was also boosted by a move from Chinese officials to soothe nerves over regulatory clampdowns on the nation’s tech and education sectors.

Beijing officials held a call with global investors, Wall Street banks and Chinese financial groups on Wednesday night in an attempt to calm nerves, as fears spread of a more far-reaching clampdown. Hong Kong’s Hang Seng rose 3.3 per cent on Thursday, although it was still down more than 8 per cent so far this month. The CSI 300 index of mainland Chinese stocks rose 1.9 per cent.

Brent crude, the global oil benchmark, gained 1.4 per cent to $76.09 a barrel.

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Man Group posts tenfold gain in performance fees




Man Group PLC updates

Man Group, the world’s largest listed hedge fund manager, reported first-half performance fees 10 times higher than a year ago, in the latest sign of the industry’s robust rebound from the coronavirus pandemic.

Strong commodity and equity markets helped take performance fees at the London-based company to $284m in the six months to June, up from $29m a year before when March’s huge market falls hit many fund returns, and the highest level since at least 2015. Performance fee profits were 50 per cent above broker consensus forecasts.

Man also posted $600m of net client inflows in the three months to June, its fourth consecutive quarter of inflows, although the figure was lower than analysts had expected. However, $6bn of investment gains in the second quarter helped lift assets under management to a record high of $135.3bn.

Column chart of Half-yearly performance fees ($) showing Man Group cashes in on market rebound

Man’s results highlight how strongly the $4tn hedge fund industry has bounced back after a turbulent 18 months for markets, including a huge sell-off last spring, as well as sharp market rotations and retail investor-driven rallies in meme stocks that some funds were betting against.

Last year, hedge funds, which have long been criticised for mediocre returns and high fees, made 11.8 per cent on average, according to data group HFR, their best calendar year of gains since 2009 in the wake of the financial crisis.

Investors have taken notice. After three years of net outflows, the industry has posted $18.4bn of inflows in the first half of this year.

Chief financial officer Mark Jones said the hedge fund industry was now benefiting from a tailwind after strong gains last year. “You saw hedge funds deliver exactly what clients wanted,” he told the Financial Times.

“Clients need new sources of return,” he added. They “are trying to reduce their bond exposure, and most have as much equity exposure as they can stomach”.

This year Man has made strong gains at its computer-driven unit Man AHL, named after 1980s founders Mike Adam, David Harding and Martin Lueck, which tracks trends and other patterns in markets.

Its $4.6bn AHL Evolution fund, which bets on trends in close to 800 niche markets, has gained 10.2 per cent so far this year and contributed $129m of the performance fees in the first half. The fund is shut to new money but Jones said that late last year it opened briefly to new investment, raising $1bn in a week.

Man’s first-half profits before tax came in at $323m, well above analysts’ forecasts. The company also said it would buy back a further $100m of shares in addition to the $100m announced last September. Broker Shore Capital said the company had posted “blowout” figures.

Man’s shares rose 2.4 per cent to 196 pence, their highest level in three years.

Last month, Man announced that chief investment officer and industry veteran Sandy Rattray would leave the company. Meanwhile, Jones is set to step down from the board and take on the role of deputy chief executive, overseeing the computer-driven AHL and Numeric units.

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