(Yicai Global) July 27 -- Chenxi Group, previously one of the largest soybean importers in China previously, has declared bankruptcy.

A court in the firm's home province of Shandong wound up the firm on July 20 due to insolvency.

Soybean trade was previously the company's core business, reaching total imports of 5.5 million tons in 2012 or 9.5 percent of the China's total soybean imports that year.

However, the soybean trade was merely a legal front for the company's financial speculation and profit-seeking activities. During its golden years of speculation, soybean trade only acted as a tool to help the company to procure loans from banks and become highly leveraged. On the other hand, the company actually was not very concerned about prices of soybean in the market.

After external conditions unexpectedly changed both at home and abroad, the speculative financial activities that had fed the company's growth became unable to support further profit-making, and even accelerated its decline.

Speculative Games With Soybeans

"Chenxi was once extremely popular and was a well-known soybean trade financing company among the entire industry," a Chinese oil industry insider told Yicai Global. Their quotation for soybean was a significant influence on the domestic market."

Nevertheless, soybean trade and soybean trade financing are poles apart.

Generally, after signing import contracts, soybean importers need apply to foreign banks for a letter of credit. After paying 20 percent to 30 percent of cash deposits, importers are granted a usance LC allowing a delayed payment of 90 days to 180 days.

With the usance LC, enterprises can borrow money from domestic banks to complete payments for imports. Due to the low interest rates on banks' loans secured through the LC, which were once as low as two percent, as well as the several months' delay in payment, some speculators saw opportunities of profiting through the exchange rate difference as well as the interest rate spreads between foreign and Chinese banks. What's more, by making use of the difference in the timing of loan procurement and repayment, some immediately invested the money made from selling soybean into real estate or even usury, which are more profitable.

Obviously, compared with the trade of agricultural products that features scarce profits, for soybean traders like Chenxi, the trade financing game of getting something for nothing seemed more attractive.

During 2013 to 2014, a period of one-way appreciation of the yuan, it was quite common for Chinese firms to conduct trade financing activities based on soybean, the industry insider said. Some enterprises even exited their major business areas, choosing to use soybean import as a financing tool. They invested the cash from underselling soybean into the usury or real estate market, and in the meantime, made speculative earnings through highly profitable projects like interest rate spreads, exchange rate differences and real-estate-related industries.

Han Shaojie, the head of Jiusan Group's foreign trade business once said publicly that soybean trade financing is essentially a business that makes profits from exchange rates and interest rates. Even though they cannot make profits from the exchange rate difference due to the depreciation of yuan, they can still get something from interest rate spreads, as financing costs in overseas markets have always been low.

Accordingly, Chenxi rapidly expanded its assets. Shao Zhongyi, the company's actual controller and board chairman even once ranked in the Hurun Global Rich List for 2016. That year, with CNY19 billion in personal wealth, he became the richest man in Shandong province according to the ranking.

Shao once admitted, importers were enjoying a golden age during the appreciation of yuan, for the fluctuation in exchange rates would facilitate their business. Indeed, he made a lot through both the exchange rate difference and interest rate spreads.

High Leverage Risks Highlight Changing Environment

As the yuan is no longer appreciating and has even depreciated in one way since 2015, coupled with the appreciation of US dollar, the continuously increasing Federal Reserve benchmark interest rate, China-US trade friction and a slowdown in China's real-estate industry, those speculative enterprises raising funds through soybean trade are gradually being eliminated by the market.

With losses in leverage arbitrage investment using LCs, some soybean importers experienced a broken capital chain which led to failures in securing new LCs. Meanwhile, their cargo ships could not be unloaded in accordance with the contract, and they witnessed a crackdown of embroiled arbitrage trading in other fields successively, Yicai Global learnt from the interview.

Chenxi, a company thoroughly focusing on trade financing, is also seeing increasingly declining business. Ma Wenfeng, an analyst at CNAgri told Yicai Global that Chenxi has been speculating on changes of the yuan's exchange as its subsidiary business. When it began importing soybeans in 2012, it started to speculate on changes to the exchange rate.

The depreciation of the yuan first impacted the firm in 2014. The recently intensified China-US trade frictions, increasing import tariffs on American soybeans and another round of falling value of the yuan were the final nails in the coffin for this once key player in the market.

"The yuan does not enjoy an obvious advantage in exchange rates," another insider told Yicai Global. "Combining stricter regulation, there has been less financing in the name of soybean imports in the market in the past two years."

He said, in fact, the bankruptcy is an inevitable result for this kind of speculative company even if there had been no trade disputes between the US and China as well as a new round of yuan depreciation.

Such a company has problems in business operations as it does not have a core competitiveness, he said, adding that professional teams can operate well in soybean trade, though they cannot ensure profits in the recent soybean market.

Yicai Global noticed that because of small gains in soybean import trade, importers began to carry out trade financing on the basis of the commodity. This means they will use the differences in LC timing to invest money in other fields or lend to others to obtain high incomes and interests while selling imported soybeans to other enterprises at a low price.

Many insiders told Yicai Global that Chenxi was the initiator of this operation.

Fund Withdrawals by Banks

Chenxi was a key industrial company in Shandong Province and already formed four main business sectors, namely, petrochemical, cereal and oil processing, international trade and cultural tourism. It has over 6,000 employees and has ranked among the top 500 Chinese private companies for seven years in a row. The total output of its petrochemical enterprise and cereal and oil processing enterprise is CNY16.9 billion (USD2.5 billion) and CNY1.6 billion in 2016, respectively; the sales revenue of trade registered CNY26.1 billion and the whole group achieved a revenue of CNY43.2 billion.

How could company Chairman Shao Zhongyi, one Shandong's richest man, now be facing bankruptcy?

Shao said in a 2015 interview that the company started to run low on funds at the end of 2014. Since mid-2014, banks gradually reduced loans to the firm through measures such as advance repayment and a reduction in loan amount. The firm's total lending decreased by one-third compared with that of 2013.

Yicai Global learned in November 2016 that Minsheng Financial Leasing requested a court to preserve property and called for the freezing of a bank deposit of over CNY77 million or seal up assets of equivalent value of respondents, including Haiyou Petrochemical Group, owned by Chenxi.

At the same time, the Bank of Communications Financial Leasing unit also sued companies such as Haiyou Petrochemical and Chenxi, requesting the court to require Haiyou returned leaseholds and equipment and compensate losses of CNY297 million and interests temporarily calculated based on the total amount of unpaid rent.

The Agricultural Bank of China signed a financial leasing contract with Haiyou in March 2013 which was guaranteed by Chenxi. As of September 2016, Haiyou should pay rent of over CNY100 million and default interest of CNY13 million.

So, why did banks 'withdraw funds' from Chenxi?

A surge in breaches of contract by soybean importers occurred in 2014 which impacted Chenxi, Changhua Group and Delisi. After the occurrence, banks strictly inspected LC financing and tightened credit loans, increasing the cost and difficulties for companies looking to obtain funds.

Speculating With Soybean

"Chenxi was once extremely popular and a renowned financer to the industry," a source with connections to China's oil sector told Yicai Global. "Their quotes for soybean were very attractively and had significant influence on the domestic market."

But trade and funding are far from the same. After signing import contracts, soybean importers need to apply to foreign banks for an LC, and after paying cash deposits of up to 30 percent, can get a letter allowing for payment delays of up to 180 days. These letters are commonly used for international commodity trading in bulk, and without one it would be almost impossible for an importer to complete payment for the transaction. The loans issued via credit letters used to be available at 2 percent interest at best.

With these, companies can borrow money from domestic banks before profiting from the foreign exchange and interest rate spreads between lender at home and abroad. Soybean importers quickly plowed the money into more lucrative sectors, such as micro lending and real estate.

Trading agricultural products generated only slim profit margins, so 'getting something for nothing' from trade financing seemed much more attractive.

When the yuan was appreciating in 2013 and 2014, it was common for Chinese companies to do this with soybean. Some even quit their core business, the oil industry source said. They monetized imported soybean by dumping them at low prices and diverting the money into property or micro lending. This way, they managed to earn substantial income from interest and forex rates during the interest-free period offered by the LC.

But these speculators phased out as the yuan began weakening in 2015, leaving few survivors.

They could not make profit from exchange rates when the yuan was depreciating, but they could still earn money from interest rate spreads as the financing costs overseas were lowered, Han Shaojie, a principal at foreign trader Jiusan Group once said in public.

Interest rates were commonly between 3 percent and 5 percent after the Shanghai Pilot Free Trade Zone fully opened to overseas lenders in February 2015. The rate once stood around 2 percent, while outbound rates for foreign currency were as low as 1.3 percent.

Importers enjoyed a golden era when the yuan was strengthening, as fluctuations in exchange rates made it easy to rake in money from bulk trades, Shao said, adding that he made a killing from exchange rate differences and interest rate spreads.

What Goes Around, Comes Around

Speculation can bring in huge profits, but there are also obvious risks -- Chenxi's demise is a clear demonstration that what goes around, comes around.

Soybean importers took advantage of leverage from the LC and when that failed, the capital chain ruptured and they struggled to get more credit, insiders told Yicai Global. As a result, cargo could not be delivered in line with contracts and other deals based around the arbitrage collapsed.

By the end of March 2014, Chenxi had an external guarantee balance of nearly CNY3.7 billion (USD544 million), making up almost 42 percent of its net assets at the time.

China Lianhe Credit Rating published a short-term bond credit report for the firm in December 2013, noting that by the end of June 2013, the company had a credit line worth CNY4.7 billion, or nearly 63 percent of net assets. The large proportion of credit made Chenxi vulnerable to trade fluctuations and exposed risks, the report said.

Public data shows that by the end of June 2013, Chenxi had mortgaged its currency assets to banks for foreign exchange loans and letters of credit. The restricted assets totaled CNY5.1 billion, or 69 percent of net assets, including CNY1 billion in bank acceptance guarantees, CNY1.3 billion in credit guarantees and CNY2.8 billion in loan guarantees.

As it borrowed more money and spent more on financing, the company's profits eroded. Its gross profit margin slid to 7.65 percent in the first half of 2013, compared with 13 percent throughout 2010.

Chenxi had prioritized speculation on the yuan exchange rate since it began importing soybean in 2012, said Ma Wenfeng, an analyst at Beijing Orient Agribusiness Consultants. The devaluation of the yuan in 2014 was a severe blow, he said, but the increased tariffs on American soybean resulting from the recent China-US trade tiff and the yuan's current weakening have proved the final straw.

"The exchange rate difference has significantly diminished in the past two years," a source familiar with the case told Yicai Global. "That coupled with stricter regulations from the State Administration of Foreign Exchange has seen industry abuse tail off. By 2015, the companies that were still speculating were the ones who needed finance."

Failure is inevitable for these speculators and would be with or without the trade dispute, because they have operational issues and are not competitive, he concluded.

Editor: William Clegg