Chinese Commodity Contagion Leads To First Letter Of Credit Settlement Failure
Submitted by Tyler Durden on 07/18/2014 17:44 -0400
At the heart of the China Commodity Financing Deals (CCFD) is the ability to leverage a letter of credit on the basis that there was some collateral somewhere that backed the risk of this rehypothecatable 'money'. Until now, the biggest concern has been "where's my copper, nickel, gold, etc..?" as the Qingdao ponzi scheme is unveiled; but, as Metal Bulletin reports, the contagion from the exposure of CCFDs ponzi has now hit Western banks. At least one western bank has stopped discount financing of copper into China after Industrial & Commercial Bank of China (ICBC) applied for the right not to settle a letter of credit it issued earlier this year, as a result of the Qingdao investigations. In other words the collateral chains were just snapped...
This is a new development in the fallout from the Qingdao warehousing scandal, in which Chinese firm Decheng Mining allegedly used false warehouse receipts to gain multiple loans from banks.ICBC's request for the right not to make this payment is a move that is lawful in the country in cases where there are concerns about fraud.It is the latest legal move by parties that may have exposure to the Qingdao fraud to try to protect their interests, sources said.But if the move was granted, it would be likely to leave its counterparties out of pocket, and would risk a renewed ratcheting-up of concerns about copper financing.The western bank, which was not an ICBC counterparty in the deal to which the injunction applies, has responded by ceasing to do some forms of copper financing...
This is a major problem as when the collateral chains break, the whole house of cards falls rapidly...
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And Citi is already actively denying any exposure...
- *CITI SAYS NO COMMODITY-LOAN EXPOSURE TO CHINESE FIRMS IN PROBE
- *CITI: COMMODITY LENDING CONTRACTS GUARANTEED BY PARENT FIRMS
- *CITI: FINANCING IS WITH MULTINATIONAL FIRMS' NON-CHINESE UNITS
Good luck with that legal case...
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But as we explained previously, LCs are crucial in the leveraging of the actual commodity deal...what does all this mean for explicit rehypothecation chain leverage (initially just at the CCFD level although a comparable analysis must be done for systemic as well) and CCFD risk exposure:
Leverage in CCFDsBelow is a demonstration of the LC issuance process in a typical CCFD. Assuming an LC with a duration of 6 months, and 10 circuit completions (of Step 1-3) during that time (i.e. one CCFD takes 18 days to complete), Party D is able to issue 10 times the copper value equivalent in the form of LCs during the first 6 month LC (as shown from period t1 to t10 in Exhibit 10). In the proceeding 6 months (and beyond), the total notional value of the LCs remains the same, everything else equal, since each new LC issued is offset by the expiration of an old one (as shown from period t11 to t20).In this example, total notional amount of LC during the life of the LC = LC duration / days of one CCFD completion* copper value = 10. In this example, the total notional amount of LC issued by Party D, total FX inflow through Party D from party A, and total CNY assets accumulated by party B (and C) are all 10 times the copper value (per tonne).To raise the total notional value of LCs, participants could:
- Extend the LC duration (for example, if LC duration in our model is 12 months, the notional LC could be 20 times copper value)
- Raise the no. of circuits by reducing the amount of time it takes to clear the paperwork
- Lock in more copperRisk exposures of parties to CCFDsTheoretically, Party B risk exposure > Party D risk exposure > Party A risk exposure
- Party B’s risks are duration mismatch (LC against CNY assets) and credit default of their CNY assets;
- Party D’s risks are the possibility that party B has severe financial difficulties. (they manage this risk by controlling the total CNY and FX credit quota to individual party B based on party B’s historical revenue, hard assets, margin and government guarantee) (Party D has the right to claim against party B (onshore entity), because party B owes party D short term FX debt (LC)). If party B were to have financial difficulties, party D can liquidate Party B’s assets.
- Party A’s risk is mainly that party D (China’s banks) have severe financial difficulties (Party A has the right to claim against party D (onshore banks), because Party A (or Party A’s offshore banks) holds an LC issued by party D). In the case of financial difficulties for Party B, and even in case Party D has difficulties, Party A can still get theoretically get paid by party D (assuming Party D can borrow money from China’s PBoC).
In brief (pun intended): a complete, unpredictable clusterfuck accompanied by wholesale liquidations of "liquid assets", deleveraging and potentially a waterfall effect that finally bursts China's bubble, all due to a simple black swan. Although, in reality, nobody knows. Just like nobody knew what would happen when the government decided to let Lehman fail.
So... is this China's Lehman?
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Just as Lehman hit the US when trust failed, this first failure of settlement in China's CFD shadow market is yet another straw on the camel's back...
Don't think it can happen? Think again - China money market rates are surging as liquidity demands soar...
Second Chinese Bond Default On Deck
Submitted by Tyler Durden on 07/17/2014 09:30 -0400
It seems like it was only yesterday when the first official Chinese corporate default in history (there have been many other ones in the past but all were quickly masked by the government to avoid a panic), Chaori Solar, entered the history books. Now it's time for default number in the country's onshore bond market as Huatong Road & Bridge Group, a company whose businesses includ bridge and highway construction, real estate, coal, eco-friendly construction materials and agriculture-related projects, based in the northern province of Shanxi, said it may miss a 400 million yuan ($64.5 million) note payment due July 23, according to a statement to the Shanghai Clearing House yesterday.
As now traditionally happens in China, first the company is exposed for being a fraud (with its management admitting to its sins, never to be seen again) and then the corporate bondholders are left holding the bag. This time won't be any different: according to Bloomberg Chairman Wang Guorui is "assisting authorities with an official investigation." Wang was removed from the Chinese People’s Political Consultative Conference Shanxi Committee on July 9 for suspected violations of the law, according to an official statement and media report last week.
What happens next is clear: "It’s very likely the company will default,” said Xu Hanfei, a bond analyst at Guotai Junan Securities Co., the nation’s third-biggest brokerage. “If it does, the event will have a big impact on investors’ risk sentiment."
Another staple of Chinese bond defaults: when reached for comment, the now shell of an insolvent company always refuses to make any comment:
An operator who answered the main line of Huatong Road today wouldn’t comment on the issues and declined to transfer the call to related people.
Also, it appears when it comes to default risk, China's rating agencies are about as ahead of the curve as their US peers: "China Lianhe Credit Rating Co. cut the company’s rating to BB+ from AA- to reflect the builder’s high default risks, according to a statement from the risk assessor today."
Some more on Huatong:
Huatong Road said in its statement yesterday that it’s exploring various channels to raise funds to pay off the one-year bond, according to the statement. It owes 429.2 million yuan in interest and principal by the due date, it said. The builder, which was set up in 1998, had 5.8 billion yuan of debt and 10.7 billion yuan of assets as of March 31, according to a separate statement in April on the Chinamoney website. It reported a profit of 62.7 million yuan for the first quarter.
We can't wait to find out just how many of those "billions" in assets have been rehypothecated countless times leading to pennies on the dollar, if any, recoveries for bondholders.
As for the big picture:
“The possible default of Huatong Road is another sign of increasing default risk among small and weak bond issuers in China as slower growth hits companies in sectors that are struggling with overcapacity and tougher financing conditions,” said Christopher Lee, Hong Kong-based managing director of corporate ratings at Standard & Poor’s. “Builders are vulnerable as the property downturn has curtailed construction investment which weakens their order book and revenues.”“Possibility of government intervention is low. Since last year, the new administration has been taking a more market-oriented approach,” said Ivan Chung, Hong Kong-based senior vice president at Moody’s Investors Service. “Regulators realize that if they provide support by intervening, it will also create more moral hazards, which is not good for the market.”Chung said more defaults may occur in sectors that are facing overcapacity, such as construction, steel and commodities.
Actually, the main reason why a deluge of defaults is inevitable, whether Beijing likes it or not, is that as we will report shortly, far from enaging in any deleveraging or "tapering" of credit injections, in the first quarter, Chinese banks saw the biggest increase in their assets in history! And since the bulk of these are in the form of loans going to already insolvent and materially impaired business, all China is doing now is throwing trillions in good money after bad. Which also means that in deciding to delay the Minsky unwind if only by a few months, China has just assured that when the collapse finally comes, it will be that much more acute.