Before it led a buyout deal for one of Li Ka-shing’s Hong Kong skyscrapers last year, few had heard of China Energy Reserve & Chemicals Group Co. Now it’s getting famous for the wrong reasons, roiling the $1 trillion Asian dollar-bond market with a default.
China Energy blamed the delinquency on about $2 billion of notes on a “tightening in credit conditions” that most other borrowers have so far weathered while making their payments. The unlisted Beijing-based oil-and-gas company jolted investors with the news in a statement that appeared on the Hong Kong exchange on May 27, three months after it had pulled out of the $5.2 billion Hong Kong office-tower deal.
The default has spurred some investors to reassess risks with Chinese firms that had previously been seen as solid bets, amid signs that authorities are more comfortable with letting borrowers renege on payments both in the domestic market and offshore. The following guide illustrates some key questions raised by China Energy’s misadventure.
How did the default transpire, and what’s the impact?
Three days before a principal payment of $350 million was due on May 11, China Energy tapped South Korean investors for a new $150 million bond, attempting to gather funds to repay the maturing debt. On May 25, Lin Jianbang, China Energy’s executive president, spurred investor confidence saying the company’s offshore unit expected to receive funds from its onshore parent by noon, enabling it to pay the debt.
When those funds didn’t arrive, the securities tumbled that afternoon. Two days later, on May 27, China Energy declared it had indeed missed principal payments on the $350 million of bonds, triggering so-called cross-defaults on its other overseas notes.
The securities are now indicated at less than 40 cents on the dollar. The default had broader implications as well — average yields on Chinese junk-rated dollar bonds have surged by about 1 percentage point since then, to around 9 percent, near a three-year high.
The company has about $2 billion in offshore notes outstanding, including the $150 million sold in South Korea. A Shanghai unit issued a syndicated loan of $400 million in the international market arranged by UBS Group AG. China Energy has 7.2 billion yuan ($1.1 billion) in bank borrowings onshore and offshore, according to 2017 annual financial records seen by Bloomberg.
To restructure its debt, the company has hired financial adviser FIT Consulting, and will meet with bondholders in coming weeks, Lin said last week. A capital injection is under consideration to pay back the $150 million securities sold in South Korea, Korean rating firm NICE Investors Service Co. said it was told.
The National Development and Reform Commission, the regulator for China’s overseas bond sales, didn’t immediately respond to a fax seeking comment on the company’s woes.
What’s the lesson for investors?
For one, South Korean investors are unlikely again to readily trust debt ostensibly guaranteed by onshore Chinese parent companies, says Kim Sang-hun, a credit analyst at Shinhan Investment Corp. That’s after they took up China Energy’s bond in early May without full realization of the company’s financial woes.
More broadly, gauging government support for Chinese companies that claim links to the state has become “a very subjective task,” CreditSights Inc. strategists wrote this month. And the China Energy case has made clear the importance of due diligence to determine the ownership structure of bond issuers to allow for a better assessment of likely parent support.
“Investors would need to pay more attention to fundamental analysis, and they should dive deeper into the credit terms of the bond offerings,” said James Arnold, head of Asia Pacific debt capital markets at Citigroup Inc. in Hong Kong. “It is only reasonable for investors to start thinking more rigorously on terms and covenants.”
So what is China Energy?
It describes itself as a state-controlled energy trading, logistics and distribution company, with operations in China and overseas, according to a 2017 bond prospectus. Trading in energy products, including fuel oil and gas, accounted for the majority of its operating revenue the last few years through June of 2017, according to the bond document. The company’s operating revenue was 37 billion yuan last year, according to annual financial results seen by Bloomberg News.
And who owns it?
The top two shareholders are China National Friend Industry Corp. and China Overseas Holding Group Co., its bond prospectus and the 2017 annual report show. However, records of the two firms aren’t apparent in China’s official corporate registry, known as the National Enterprise Credit Information Publicity System. Lin, China Energy’s executive president, said by phone last week that all the shareholders have proper records on government websites, without giving directions of how to find them.
Below are four shareholders listed in the annual report:
|Shareholder Name||Stake Holding||Official Corporate Record||Taxpayer Record|
|China National Friend Industry Corp.||49%||No||Yes|
|China Overseas Holding Group Co.||27%||No||No|
|China Hualian International Trading Co.||15%||Yes||Yes|
|Guoneng Natural Gas Import and Export (Beijing) Co.||9%||Yes||Yes|
- China National Friend Industry engages in air freight and airborne remote sensing, according to a court filing in 2017, and had an affiliation with the People’s Liberation Army’s air force back in the 1980s, though it’s unclear whether that’s still the case. No working phone number could be found for the firm.
- China Overseas describes itself a state-owned enterprise on its website and its operations span across transportation, real estate and finance. An operator answering the phone at the firm declined to to provide any information asked by Bloomberg News and refused to connect through to a spokesperson.
- Guoneng Natural Gas is an indirect subsidiary of state giant China National Petroleum Corp.
- China Hualian is owned by China Economic Cooperation Center, a unit of the China Communist Party Central Committee’s International Department, which is involved in decision-making related to national energy security.
How about its key assets?
- The company has refining capacity and at least 590,000 barrels of fuel storage in northeast China, according to its website. In February, China Energy said it planned to invest 27 billion yuan to build a coal-to-chemicals industrial park without identifying a location.
- As of Dec. 15, the company was planning to purchase a stake in the Sacha oil field in Ecuador for $1.2 billion with a further investment of $1.8 billion by 2020, according to the bond prospectus. The reserve is estimated to hold about 369 million barrels of crude.
- In 2016, it bought a two-thirds equity interest in Rockyview Canada Inc., with land estimated to hold 54.9 billion cubic feet of natural gas for $300 million, the bond document showed. In the same year, it acquired Endurance Energy Ltd., also based in Canada, for C$150 million.
- China Energy last year signed strategic cooperation agreements with 12 banks, including Bank of Communications and China Development Bank, to invest in oil and gas projects in countries including Kazakhstan, Tunisia, the U.S. and Canada, according to its website.
What’s the key takeaway?
Basic corporate registration records as asserted in public fundraising documents should be readily accessible. If not, that should be a big warning sign for bond investors, experts say.
"If in fact there are no corporate records for the largest stakeholders in bond prospectuses, then clearly this indicates very poor due diligence," said Bill Majcher, who has done risk consulting in countries including China and is president of EMIDR Ltd. a Hong Kong-based corporate-risk firm. "It raises a very big red flag to me that the whole exercise may have been designed to be a fraud," he said, while refraining from specific comment on China Energy.
— With assistance by Lianting Tu, Jing Yang De Morel, Aibing Guo, Aaron Clark, Steven Yang, Liuhan Yang, and Carrie Hong