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S&P downgrades Hongqiao, cites heightened corporate governance risks

S&P Global Ratings downgraded its long-term corporate credit rating on China Hongqiao Group on Monday, citing heightened corporate governance risks.

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The Chinese aluminum group is the world's largest aluminum producer. It has yet to publish its 2016 annual report, and has not responded to fraud allegations that surfaced in February about accounting irregularities, under-reporting of input costs, and allegations of connected party transactions.

Trading in Hongqiao's shares have been suspended on the Stock Exchange of Hong Kong since March 22. Hongqiao has also switched auditing firms twice in the last three months.

S&P lowered on Monday its long-term corporate credit rating on Hongqiao to 'B' from 'B+', also lowering the issue rating on Hongqiao's outstanding senior unsecured notes to 'B' from 'B+', and the long-term Greater China regional scale ratings and notes on Hongqiao to 'cnB+' from 'cnBB-'.

Additionally, all the ratings remain on credit watch with negative implications, where they were placed on March 24, S&P said.

"We consider the prolonged delay in publishing its 2016 annual report and the recent auditor change to be signs of deficiency in internal controls and weak corporate governance. Further delays in the release of its financial statements may heighten the company's liquidity risk," S&P said.



Two weeks ago, Hongqiao announced the appointment of ShineWing HK as its new auditor, three months after the appointment of Baker Tilly to replace Ernst & Young.

"We also view the delayed response to allegations by short sellers presents a less-than-favorable perception on the company's transparency. Hongqiao could face increasing liquidity risk if the company can't publish its audited 2016 financial statements by end of August," S&P said.

"The company will need to apply for a further extension of the waiver if this deadline is not met. While creditors have already extended the deadline twice, it is not certain that the company will be granted a further waiver. If the banks instead ask to accelerate the loan repayment, the company may not have enough offshore cash on hand."


AUDITED ANNUAL REPORT DUE AUGUST 31


Earlier this month, Hongqiao's creditors granted an extension of a waiver in relation to its $700 million syndicated loan. The waiver was extended until the end of August 2017, from end of June. S&P noted on July 6 that this meant Hongqiao was obligated to provide its audited 2016 annual report by the new deadline or it will be in technical default of the terms of its loan.


FRAUD ALLEGATIONS YET TO BE ADDRESSED


"We aim to resolve the CreditWatch as soon as we have more clarity on the publication timing of Hongqiao's audited 2016 annual report, the validity of the short-seller reports, and the impact of the above on Hongqiao's liquidity and overall credit profile."

"We could lower our ratings on Hongqiao by one or more notches if the company's liquidity deteriorates substantially or if any of the allegations in the short-seller reports, including those related to production costs, prove to be true. We could also suspend the ratings if no new information is available for a prolonged period."

"We could affirm the ratings on Hongqiao if the company publishes audited 2016 annual report with an unqualified auditor's opinion, resumes trading of its shares, responds to the short-seller reports with solid evidence, while maintaining adequate liquidity position."


TIMELINE OF RECENT EVENTS


March, 21, 2017: Hongqiao announced that it may delay the release of its 2016 annual results because it needed more time to address issues raised by its auditor.
March 22, 2017: Trading in Hongqiao's shares was suspended. April 18, 2017: Hongqiao announced that it obtained an extension from a majority of the creditors of the $700 million syndicated loan on the publication of its 2016 financial results. The waiver is valid until end-June 2017.
April 28, 2017: Hongqiao announced that Ernst & Young resigned as its auditor with effect from April 27, 2017. Baker Tilly Hong Kong Ltd. was appointed as its new auditor.
April 28, 2017: Hongqiao's two major domestic subsidiaries, Shandong Hongqiao New Material Co. Ltd. and Shandong Weiqiao Aluminum and Power Co. Ltd., published their 2016 annual reports, and their financial statements for the first quarter of 2017. The 2016 annual reports were audited by a Chinese auditing firm CAC CPA Limited Liability Partnership with unqualified opinion.
May 2, 2017: Hongqiao announced its preliminary unaudited financial information for the period ended December 31, 2016.
June 27, 2017: The company announced that it redeemed in full the $400 million senior unsecured notes that were due on June 26, 2017.
June 28, 2017: Hongqiao announced that it entered into a strategic cooperation agreement with CITIC Bank for the grant of no more than Yuan 20 billion credit and the provision of financial services to the company.
June 30, 2017: Hongqiao's creditors on its $700 million syndicated loan extended a waiver with regard to suspension of its shares trading and the delay in the publication of its annual report; the waiver now extends until August 31, 2017, from end-June previously.
July 12, 2017: Hongqiao announced that Baker Tilly Hong Kong Ltd. resigned as its auditor, and Shinewing HK has been appointed as its new auditor.

Hongqiao is able to produce 9 million mt/year of aluminum, but had been operating at a capacity of 7 million-8 million mt/year for the year to date. Then on June 20, Hongqiao reduced its metal production capacity further by 250,000 mt/year.

A company official declined to specify the reason for the curtailment. Other market sources however, told S&P Global Platts that Beijing was cracking down on unlicensed smelting operations.

Hongqiao can produce 13.5 million mt/year of alumina in China but has been turning out 13 million mt/year due to emission issues. Additionally, the group has a 56% share in the Well Harvest Winning Alumina Refinery in Indonesia, a joint venture with the Harita mining group Harita Jaya Raya, and Singapore Winning International Group. The Well Harvest refinery's annualized production rate is a little under 1 million mt/year.

S&P Global Ratings and S&P Global Platts are part of the S&P Global group of companies.

--Joanna Lim, joanna.lim@spglobal.com
--Edited by Irene Tang, irene.tang@spglobal.com