China Steel Mills Drop as Credit Squeeze, Ore Panic Grips

Chinese steel companies, the world’s largest, helped propel Asian producers to a seven-month low this week as concern builds that some mills face financial difficulty amid a government credit squeeze.

“They are having trouble accessing finance,” Yunde Li, chairman of Ishine, a unit of China Zhongsheng Resources Holdings Ltd., which processes iron ore in Shandong, said yesterday in an interview in Perth. Some of Ishine’s steel mill customers cannot make their payments to his company, Li said through a translator, declining to name the companies.

Closely-held steel mills in China are struggling to get funding and that’s led to panic selling of iron ore, according to Morgan Stanley. Premier Li Keqiang said today China needed tough measures and rules to fight pollution after its top banking regulator said this week strict credit guidelines will be imposed on mills that were big polluters and users of energy.

“The capital squeeze on steel traders has started to affect mills,” said Henry Liu, Hong Kong-based executive director of China Merchants Capital and head of its commodities research department. “It looks like the credit crunch is worsening.”

Iron ore this week had its biggest drop in more than four years, spooked by the credit squeeze and a surge in stockpiles. The Bloomberg Asia Pacific Iron/Steel Index, which includes China’s Baoshan Iron & Steel Co. and Angang Steel Co. and Japan’s Nippon Steel & Sumitomo Metal Corp., dropped for a third day yesterday, to the lowest since July 31. The index gained 0.9 percent today.

Shadow Banking

“There’re talks some mills are facing tightening credits, as they may be charged with higher interest rates on loans,” said Hu Shunliang, investor affair representative with Maanshan Iron & Steel Co. It hasn’t affected Maanshan, Hong Kong’s second-largest listed steelmaker, he said.

Premier Li’s strategy of driving up interest rates to reduce leverage is exposing a shadow banking network 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.

Aggregate financing in China decreased to 938.7 billion yuan ($153 billion) last month, from January’s record 2.58 trillion yuan, amid a crackdown on shadow lending, a government report this week showed.

“To declare a war on smog doesn’t mean we are declaring a war on nature,” Li said today, according to a report by the official Xinhua News Agency. “Rather, we are going to declare a war on our own inefficient and unsustainable model of growth and way of life.”

Trim Producers

“China is moving to trim small steel companies to eliminate overcapacity,” Shang Fulin, chairman of the China Banking Regulatory Commission, told a briefing in Beijing on March 11. Secondly, “if highly polluting and highly energy-consuming companies don’t meet environmental evaluation requirements, banks won’t issue loans to them,” he said.

China’s move to cut overcapacity and restrict credit in the steel industry has been well flagged, Sam Walsh, chief executive officer of Rio Tinto Group, told reporters today in Brisbane, Australia. “There is overcapacity in the Chinese steel industry, so in terms of that industry’s ability to produce steel, it won’t impact on the total volumes.”

Major Chinese mills aren’t likely to be affected, he said.

Ore Price

Ore with 62 percent iron content delivered to China’s Tianjin port fell 8.3 percent to $104.70 a dry ton on March 10, according to data from The Steel Index Ltd. It rose 2.4 percent to $107.40 a ton yesterday.

“High iron ore stocks in China, continued credit tightening, and a seasonal build-up in finished steel inventories in China, all point to downward price pressure on the entire value chain from upstream raw materials to steelmaking,” Sanford C. Bernstein & Co. analysts led by Vanessa Lau said in a report today.

China is trying to cut pollution, rather than improve industry economics and there’s little chance it will announce a further curtailment program that will have a “material impact” on steel markets, the Bernstein analysts said.

Margin Calls

China’s loan practices have artificially inflated the iron ore price as demand for collateral boosted imports, which led to average prices of $130 to $135 a metric ton at the end of 2013, IG Markets Ltd. said in a March 11 note. It’s believed most of the inventory purchases are unhedged so margin calls are rising and losses are mounting, IG Markets’ strategist Evan Lucas said in the note.

While this could see inventory-dumping as losses become unsustainable, Lucas said it’s more likely banks will take control of inventories as traders default. Banks aren’t likely to sell cargoes until the market recovers, he said.

China is studying the default risks to companies that use iron ore as collateral to obtain financing, and may warn banks about the dangers of lending money in such cases, people with direct knowledge of the matter said today. Regulators are weighing the risk to banks from the falling price of iron ore and a weaker yuan, said the two people, who asked not to be identified because the deliberations haven’t been made public.

China had its first onshore bond default after Shanghai Chaori Solar Energy Science & Technology Co., a solar-panel maker, last week failed to pay interest on notes due March 2017. That’s stoking speculation more companies in overcapacity industries in China may miss debt payments.

Closely held steel mills in China are “struggling to get funding at the moment,” said Joel Crane, a Melbourne-based commodity analyst with Morgan Stanley Australia Ltd. “So they’ll be refusing both contracted and spot iron ore, and that’s led to the panic selling.”

BHP Billiton Ltd., the world’s largest mining company, is protected from payment defaults on iron ore shipments, said Jimmy Wilson, its iron ore president.

“We have assurances around each of the cargoes,” Wilson said in Perth on March 11. “We sell everything against letters of credit.”

— With assistance by Rebecca Keenan, and Helen Yuan

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