Caixin
Dec 25, 2017 06:27 AM
ECONOMY

The Rescue of China’s Largest Bond Defaulter

A worker watches steel production at a Dongbei Special Steel plant in the northeastern city of Dalian in October 2015. Photo: IC
A worker watches steel production at a Dongbei Special Steel plant in the northeastern city of Dalian in October 2015. Photo: IC

Four months after its debt-restructuring plan was hammered out, China’s largest bond defaulter Dongbei Special Steel Group Co. is slowly crawling out of the grave.

Dongbei Special’s main production facility in the northeastern port city of Dalian has turned a profit after nearly six years of losses, a source from a creditor bank told Caixin. That followed a nine-month struggle to settle more than 45 billion yuan ($6.8 billion) in debt and invite in fresh capital from new investors.

The debt-relief battle surrounding Dongbei Special is a peek inside China’s campaign to deal with ballooning debt of state-owned firms.

Dongbei Special is China’s largest producer of specialty steel for sophisticated applications such as nuclear, military and space projects. It was once a source of deep pride for its hometown of Liaoning Province in the heartland of China’s rust belt.

Its fall was remarkable. Between March and late September in 2016, Dongbei Special failed to repay 10 batches of corporate bonds worth 7.1 billion yuan (US$1 billion). That marked a new chapter in the history of China’s bond market, which previously hadn’t had bond defaults because of government guarantees.

Company Chairman Yang Hua committed suicide five days before the first default on about 800 million yuan worth of bonds.

In October of 2016, a local court ordered the company to enter bankruptcy reorganization proceedings. That set off a tug-of-war among the debt-ridden Dongbei Special, its 1,911 creditors, local officials and potential investors.

The dust settled in August when a court in Dalian approved a restructuring plan that was a mix of partial repayment, debt-to-equity swaps and new investment. Most creditors were offered either compensation in cash at 22.09 percent of value or a debt-for-equity swap.

Creditors have accepted to swap about 84.6% of their debts into Dongbei Special’s equity, Caixin has learned.

Meanwhile, Jiangsu Shagang Group Co. Ltd., China’s largest privately-owned steelmaker, agreed to invest 4.46 billion yuan to become the largest shareholder of Dongbei Special, with a 43% stake. Liaoning government-backed Benxi Steel Group said it would invest 1.04 billion yuan for 10% of Dongbei Special.

After the restructuring, Dongbei Special’s previous major shareholder – the Liaoning provincial state-owned asset administration and Heilongjiang provincial government – will no longer hold any shares of the company. Creditors are set to hold as much as 46.6% of the steelmaker after the debt-for-equity swaps.

The restructuring plan has apparently helped Dongbei Special stay afloat. Caixin learned from sources close to the company that the combined 5.5 billion yuan investment from Shagang and Benxi has arrived in Dongbei Special’s accounts. Under the plan, 3 billion yuan will be used to repay debt and the remaining 2.5 billion yuan will supplement Dongbei Special’s operating capital.

The business restructuring is also underway, led by Shagang, and steel production is on the rise, a creditor said.

Dongbei Special enjoyed a bit of good luck: As the company was moving along this year on its reorganization push, China’s steel industry saw prices soar, thanks to economic recovery and the fight by central and the campaign to cut excessive capacity.

Steelmakers have seen their business revive. The benchmark steel price index had climbed 19% by the end of November from the beginning of this year, following a 72.8% rise throughout 2016, according to Qianzhan Industry Research Institute. Overall profit of iron and steel companies increased 160% year-on-year in the first nine months this year, data from the National Statistics Bureau show.

A source from a creditor bank said most creditors believe there is still plenty of room for China’s special steel sector to grow as the country’s industries upgrade. Dongbei Special, with good technology capacity, has the potential to grow if it is managed more efficiently, the source said.

The debt bomb

Many of Dongbei Special’s creditors were surprised when the default occurred because the company had shown little sign of capital crunch.

But a Liaoning government official told the news media in October 2016 that the provincial government had in March of that year helped Dongbei Special obtain 1 billion yuan in funds to help prevent an earlier default.

Creditors said they were kept in dark about Dongbei Special’s struggles. The steelmaker had stopped releasing any financial figures beginning in September of 2015. Data released with the final restructuring plan showed that Dongbei Special had assets worth 19.1 billion yuan as of Oct. 10, 2016. That figure is a sharp drop from 30 billion yuan the company reported at the end of 2014.

An SOE source linked Dongbei Special’s sharp decline in assets to the local government’s intentional inflation of growth data. In January, the governor of the northeastern province of Liaoning admitted that city and county officials in the region had falsified fiscal revenue and other data from 2011 to 2014.

Sources close to Dongbei Special said the company’s capital strain is a result of radical expansion. In 2007, shortly before the steel market took off after China injected 4-trillion yuan into the economy in a stimulus package, Dongbei Special invested 5.6 billion yuan to build the production facility in the outskirts of Dalian. In 2010, the facility was further expanded, with an additional 15.6 billion yuan investment.

But the boom in the steel market turned into a glut in 2014. The government moved to cut excessive capacity, making it difficult for steelmakers to access new bank credit and leading to a capital crunch.

Plans to expand

The bankruptcy proceedings started on Oct. 10, 2016, and the government-led reorganization team of Dongbei Special went on to hold nearly 100 meetings with potential investors and creditors to find the right lifesaver.

Major state-owned firms including Anshan Iron and Steel Group, CITIC Pacific Special Steel Holdings, China Baowu Steel Group and Taiyuan Iron and Steel Group were among the potential investors, Caixin has learned.

The short list was revised constantly, and it wasn’t until late June – less than one month before the deadline for Dongbei Special to submit a restructuring plan to avoid liquidation – that the reorganization team and creditors picked the investment from Shagang.

Shagang’s takeover as the largest shareholder raised concerns that some of Dongbei Special’s 22,000 employees might be upset that the private company could change the state-owned-enterprise employee culture, which usually means better welfare. But creditors eventually cast their votes to the private steelmaker due to its reputation for strong management.

With total assets of 150 billion yuan, Shagang has been known for its highly efficient management and ability to control costs. In 2016, Shagang registered 198 billion yuan in revenue, with 5 billion yuan net profit, its eighth consecutive profitable year despite the slowdown in the overall steel sector.

For Shagang, the investment in Dongbei Special is in line with its strategy to shift its business focus from general steel to high-end special steel products. Shagang plans to expand its annual capacity of special-steel production to more than 10 million tons, sources close to Shagang said. Currently, Shagang’s special-steel capacity, including Dongbei Special, is close to 7 million tons.

Shagang outlined a promising prospect for Dongbei Special – to achieve 300 million yuan net profit in 2018 and keep growth over the following three years. And then Shagang plans to restructure Dongbei Special with other assets and list the new entity on the stock market.

Government’s role: ‘intervention or support’?

Analysts are hailing the Dongbei Special Steel case as a successful example of bankruptcy restructuring in China under market rules.

The central government has encouraged the use of the bankruptcy law by indebted companies to restructure amid ongoing efforts to deleverage the economy.

The number of bankruptcy applications in China jumped 53.8% last year to 5,665. Among the total, bankruptcy-restructuring cases rose 85.2% year on year to 1,041, according to the Supreme Court.

In Dongbei Special’s case, the creditor committee, mainly formed by banks, played a crucial rule in coming up with the restructuring plan, although some smaller creditors complained that their interests were not well represented.

An industry policy analyst said the Dongbei Special restructuring plan offered better protection to its creditors than most previous bankruptcy cases. But he said had the steelmaker entered bankruptcy proceedings earlier, all parties would have incurred smaller losses.

Like many debt-strapped SOEs, Dongbei Special’s restructuring is closely entwined with the local government. The team behind the company’s bankruptcy reorganization consisted mainly of officials from the Liaoning provincial government. In late July, Liaoning Deputy Provincial Governor Cui Fengling flew to Jiangsu to meet Shagang’s Chairman Shen Wenrong in person, pushing forward a partnership, Caixin learned from sources close to the matter.

“When government officials directly negotiate with private investors, should it be seen as government intervention or support?” asked the policy analyst.

Local governments are still essential to any major bankruptcy reorganization case in China because private investors are reluctant to get involved without clear government support, the analyst said.

“But how and how much governments should get involved remains a question,” he said.

Contact reporter Han Wei (weihan@caixin.com)


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