Monday, 9 March 2009

The Bank Behind China’s Overseas Growth

Give credit to the China Development Bank for China’s new Russian energy, Brazilian oil and Australian mine investments.

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Guanyu said...

The Bank Behind China’s Overseas Growth

Give credit to the China Development Bank for China’s new Russian energy, Brazilian oil and Australian mine investments.

Zhang Zheyu and Dong Lingxi, Caijing
9 March 2009

After four months of tough negotiations, Chinese and Russian officials February 17 signed a package of energy cooperation agreements, finalizing a credit-for-oil deal worth US$ 25 billion.

The package includes a plan for a pipeline connecting Russian energy fields to Chinese consumers, long-term crude oil trading deals, and a loan from Chinese banks to Russian oil firms.

The deal marked the first time that China combined contracts for loans, oil supplies and pipeline construction. It also underscored the increasingly ambitious moves of a former state policy bank that recently went commercial -- China Development Bank (CDB).

In addition to the Russian agreements, CDB helped broker two other major deals between foreign and Chinese enterprises in February: An investment by Aluminum Corp. of China (Chinalco) in Australian miner Rio Tinto, and supply agreements between China National Petroleum Corp. (CNPC) and China Petrochemical Corp. (Sinopec) with Brazil’s Petrobras (PBR).

In the Sino-Russian agreement, CDB is taking the lead in lending billions of dollars to a pair of Russian state-owned energy providers. Rosneft is in line for US$ 15 billion while Transneft, which has a monopoly on pipeline construction, would get US$ 10 billion. The Export and Import Bank of China (Exim) will contribute to the loan package as well.

In return, Russia agreed to supply 15 million metric tons of oil annually for the next 20 years from new fields in eastern Siberia.

Meanwhile, Caijing learned that CDB and Exim would jointly arrange a syndicated loan for a separate deal announced February 12 in which Chinalco would invest an additional US$ 19.5 billion in Rio Tinto. CDB also plans to offer PBR loans worth US$ 10 billion for preliminary oil supply agreements with CNPC and Sinopec.

In another oil agreement, CNPC signed a memorandum of understanding with the Venezuelan oil firm PDVSA for between 80,000 and 200,000 barrels of oil every day to pay off a CDB loan to Venezuela.

Altogether, CDB is now working as the potential lead lender for US$ 60 billion in credit packages.

Market Pricing

The oil loan deal between China and Russia started taking shape with the signing of an energy memorandum in Moscow last October. Both countries expected to conclude the agreement by the end of 2008. However, negotiations repeatedly ran into disagreements over lending rates and loan guarantees, stalling the process several times.

CDB was a major participant in the talks. A bank source told Caijing that “the negotiations were tough. In addition to lending rates, interest margins and loan terms, we also had to consider a risk compensatory mechanism that would be acceptable to us.”

According to a Chinese source close to the negotiations, the latest round of talks began February 13, with lending rates again playing a key role. The two sides finally agreed to adopt a partially floating interest rate pegged to the London Interbank Offered Rate (Libor) using a special pricing mechanism to hedge against extreme fluctuations. The rate is expected to float between 6 and 7 percent – higher than a once discussed range of 5.5 to 6 percent.

“The basic formula is the floating Libor rate plus a fixed interest margin,” said the CDB source. “This is also an international practice.

“The loan rate is a business secret for commercial banks,” said the source. “It is set by operation strategy and risk preference. We set the final rate according to our historical data, with consideration of financing costs, tax and management costs.”

The source added that the rate “at least won’t be a loss” for CDB.

Caijing learned that pricing mechanisms for CDB loans to Petrobras and PDVSA would be similar to those used in the deal with Russia.

According to Xu Wenhong, an Eastern Europe expert at the China Academy of Social Sciences (CASS), the 6 to 7 percent lending rate set for the Russia borrowers is modest but will bring higher yields than U.S. Treasury bonds.

CDB’s major financing source is the interbank bond market. Last year, the bank issued 620 billion yuan worth bonds, accounting for 20 percent of all interbank bonds issued that year in China.

The Russian deal is not without risk. The 20-year term for the Russian companies is the longest ever for a CDB loan. Current financing woes and the economic downturn in Russia pose potential longterm risks for the bank.

Liu Yihui, a financial researcher at CASS, said “considering Russia’s national financial situation, CDB won’t have to bear too many risks due to a fixed interest margin.

“But more risks may be tied to political relations between China and Russia,” Liu said. Whether dangers emerge “will be decided by the way they balance each other’s interests.”

Other analysts warn that China’s risk dispersal mechanism is inadequate, and that in the wake of the latest agreements, the market will now test CDB’s capacity to manage long-term risks.

CDB, however, is taking a more pragmatic approach to risk assessment.

“Russia lacks money, while China lacks oil,” said the bank source. “That’s a business interest.

“The recent loan deals, including the Russian deals and the Chinalco deal, are being processed according to CDB’s normal loan review procedure,” a bank source said. “Pricing is considered according to financing costs, taxes and management costs.”

CDB Outreach

CDB President Chen Yuanzeng once promised the bank would actively expand business overseas and promote international cooperation, while at the same time support Chinese company efforts to expand overseas. So several years ago, the bank dispatched working teams to seek loan deals in Venezuela, Russia, Africa and Central Asia.

Now, Chinese companies going abroad may prefer CDB over all other Chinese commercial banks. A source at the government’s Central Huijin Investment, the loan application procedure is less complicated at CDB which, unlike other banks, is not listed on the stock market.

“CDB’s involvement in these deals follows the principal of providing development finance which usually has little profit but fewer risks,” a CDB investment department source said. “Although the bank has been transformed into a commercial bank, following State Council direction, it still needs to assist with the country’s development strategy.

“But we have insisted market practices in each deal,” the source added.

Mineral Interests

The foreign expansion strategy also influenced CDB’s decision to finance Chinalco’s investment in Rio Tinto.

The proposal, which is now being considered by Australian government regulators, followed a late January decision by the State Council to offer a stimulus package for the steel industry that encouraged qualified enterprises to set up operations in overseas mining sectors. The government promised financial support overseas expansions.

CDB’s fortunes have improved since 2004, when the bank was embroiled in an unsuccessful attempt by China’s Minmetals Corp. to buy the Canadian mining company Noranda for US$ 4.1 billion. CDB hoped to finance what would have been the largest overseas acquisition ever by a Chinese company.

CDB worked out a financing plan that called for providing US$ 2.3 billion in loans to Minmetals with other banks, including the Industrial and Commercial Bank of China and Bank of Communications.

Although the deal was eventually rejected by the National Development and Reform Commission, it was a good practice run for CDB’s effort to finance overseas deals.

Last year, CDB finally entered the winner’s circle by taking the lead in financing Chinalco’s successful, US$ 14 billion investment in Rio Tinto – a forerunner to the latest proposal, for which Chinalco plans to complete fund-raising by March 31.