Vicious Cycle Seen as Ore Pile Evokes Steel Bust: China Credit

China’s record imports of iron ore and copper, driven by traders who use them as loan collateral, risk repeating the vicious cycle of repayment difficulties and falling prices already seen in the steel-trading market.

Xiao Jiashou, known as the “steel-trading king” in Shanghai, had his assets frozen as China Minsheng Banking Corp. sues for money owed. Lenders seeking repayment are finding irregularities, including the same pile of materials used as collateral for multiple borrowings, China International Capital Corp. said. Money-market costs have surged, with the benchmark three-month Shanghai Interbank Borrowing rate jumping to 5.6 percent yesterday from 3.89 percent in June 2013.

Premier Li Keqiang’s strategy of driving up interest rates to reduce leverage is exposing a shadow banking underbelly in the world’s second-largest economy as companies struggle to repay loans from trusts, asset managers and commodity-funding businesses. About 40 percent of the iron ore at China’s ports are part of finance deals, Mysteel Research estimates.

“The risk comes when metal prices fall by a large magnitude within a short time, driving down the value of the collateral,” Yang Changhua, a researcher with Beijing Antaike Information Development Co., said in a Feb. 19 interview. “Borrowers, forced by their bankers to repay loans or to top up collateral, will have to sell the metals, sinking market prices even further and begetting a vicious cycle.”

The yuan in Shanghai slid 0.41 percent this week to 6.0920 per dollar, set for its biggest loss in two years, according to China Foreign Exchange Trade System prices. China’s sovereign bond risk climbed three basis points to 90.50 basis points, credit-default swap data compiled by CMA show.

Prices Slide

Steel reinforcement-bar futures in Shanghai have fallen 19 percent in the past year, while iron ore delivered to China’s Tianjin port dropped 22 percent, according to The Steel Index Ltd. Goldman Sachs Group Inc. retained its “cautious view” on copper in a Feb. 18 report, forecasting London Metal Exchange prices will slip to $6,600 a ton in six months from $7,140 yesterday.

Traders began having trouble repaying loans when steel prices in China slumped 38 percent in the seven months through August 2012 as the economy slowed. In the southern city of Foshan alone, local banks have given 100 billion yuan in credit to steel traders, Caijing magazine reported this week, citing a local banker it didn’t name. Loans to the sector helped drive non-performing loans in Yunnan province to 5.86 percent as of November 2013, the magazine said, citing a China Banking Regulatory Commission official.

Poster Boy

Xiao, once the poster-boy of the steel-trading industry, had his 29.2 percent stake in Ningxia Xinri Hengli Steel Wire Co. seized due to a loan dispute with China Minsheng, the company said in a Jan. 30 statement.

At China Citic Bank Corp., bad assets surged from 2011 to 2013 mainly because of non-performing loans to the steel-trade industry, Moneyweek magazine reported on Feb. 17, citing bank President Zhu Xiaohuang. The lender said on Dec. 12 that it plans to write off 5.2 billion yuan of bad debt for 2013.

At least a third of China’s 200,000 steel-trading firms will collapse as part of the credit crisis which started at the end of 2011, the official Xinhua news agency said Feb. 7, citing industry estimates. Nanjing Iron & Steel Co. said last month its 2018 bonds may stop trading due to losses.

Companies have taken desperate measures to survive. The PBOC is probing a loophole that allowed executives at steel traders and other companies to bridge cash shortages for their firms by exceeding credit-card limits to raise as much as 10 billion yuan in December and early January, according to three people familiar with the matter.

Record Shipments

China’s shipments of copper and iron ore surged to a record in January as cash-starved companies brought in cargo to secure lines of credit. Ore stockpiles at ports climbed to an all-time high of 100.25 million tons last week, up 26 percent in the past 12 months, according to Shanghai Steelhome Information Technology Co. Copper inventory in Shanghai’s bonded warehouses jumped 27 percent since the beginning of this year to 700,000 tons, according to Goldman Sachs.

The super cycle that led commodities to almost quadruple from 2002 to 2011 is reversing, with prices set to drop 3 percent in 12 months, Jeffrey Currie, Goldman’s head of commodities research, wrote in a Jan. 12 report.

Last month’s record iron-ore imports defied weak physical demand around the Lunar New Year as the price of the steel-making material shipped to Tianjin port slumped by 10 percent this year as of Feb. 12, while inventory of the end products piled up, Xu Xiangchun, chief analyst at Mysteel, said in a Feb. 12 phone interview.

Commodity Financing

Commodity-financing companies typically place orders with overseas companies and then apply for a letter of credit from a foreign lender, which they use to import the material. They sell the cargo in the domestic market and invest the money in high-yield debt such as trust-fund products and bonds issued by local government financing vehicles. At the end of three months, the usual loan tenure, they redeem the debt and repay the banks.

Chinese companies pay an average 6.08 percent to sell yuan debt on the mainland, 0.9 percentage point more than a year ago and 1.5 points higher than their average borrowing cost offshore, according to Bank of America Merrill Lynch indexes.

“Those cash-starved steel mills or trading firms don’t care whether steel or iron-ore prices are falling,” said Zhang Jizhou, a trader at Ningbo Future Import & Export Co. “Their priority is to get cash flow so they can survive.”

Manufacturing Weakens

A Chinese manufacturing index fell to the lowest level in seven months for February, with a preliminary reading of 48.3 for a Purchasing Managers’ Index released yesterday by HSBC Holdings Plc and Markit Economics. A number below 50 indicates contraction. The yield on China’s 10-year government bonds has risen 96 basis points in the past 12 months to 4.53 percent on Feb. 19.

“China can have lots of imports but eventually these imports will still need to be sold and absorbed in the domestic market,” said Sijin Cheng, an analyst at Barclays Plc. in Singapore. “If underlying demand doesn’t pick up it will slow that trade and we might see prices in China becoming very weak.”

— With assistance by Feiwen Rong

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