FOR THREE YEARS running, defaults on Chinese corporate debt have exceeded 100 billion yuan ($15 billion). Defaulters increasingly include state-owned enterprises, signalling that Beijing is no longer extending an implicit guarantee, even to its own.
The pivot towards market-based pricing of credit and away from policy lending (also known as unproductive investment) is to be welcomed. It demands better credit decisions by lenders and implies capital will go to the firms that can best use it.
However, Beijing’s new approach also entails risk, mainly if debt repricing happens too quickly, causing a domino-effect of corporate defaults that spill over into other markets.
The latest defaults show how real this risk is.
Earlier this week, a logistics subsidiary of Jizhong Energy Group, which is owned by the Hebei provincial government, missed a scheduled repayment of principal and interest on a 500 million yuan ($76 million) trust loan. Facing a potential cascade of cross-defaults on the parent company’s bonds that would have been triggered by its subsidiary’s default, the money was found to make the payment to the lender four days late, but still within a grace period.
Word is that the financing was arranged through the good offices — and no doubt hefty local arm twisting — of the Hebei provincial government, which wanted to avoid the political awkwardness that followed the surprise delinquency of the Yongcheng Coal and Electricity Holding Group earlier in the month.
On November 10, the state-owned coal miner in Henan province unexpectedly missed a repayment due on a 1 billion yuan of short-term commercial paper, despite having presented a healthy cash position in October, the very month it issued the debt. That raised some more red flags for investors about hidden risks in China’s bond markets.
Investors were already uneasy following a default late last month by Huachen Automotive Group Holdings, the parent of the Chinese joint venture partner of German vehicle maker BMW, and a AAA-rated issuer.
They were further discomforted by regulators promising to crack down on misconduct in the corporate bond market. A statement following a meeting of the Financial Stability and Development Committee chaired by Vice Premier Liu He warned that ‘acts of intentional debt evasion’ would be severely punished. Yongcheng, which was also AAA-rated, its underwriters, rating agency and accountants are now under investigation for possible wrongdoing, including fraud.
Nevertheless, the explanation may be as simple, if scarcely less reassuring, as that Yongcheng’s parent company, Henan Energy and Chemical Industry Group, was using Yongcheng’s earnings to cover losses in other businesses. The scale of the shortfalls is indicated by the fact that last year Yongcheng, which is the country’s leading producer of high-grade anthracite, contributed 995 million yuan to Henan Energy’s group profit of 38.8 million yuan. And, yes, you did read that right.
In October, the Henan provincial government provided a liquidity injection of 7 billion yuan to Henan Energy, suggesting the shortfalls were, if anything, getting bigger.
Some reports claim that Yongcheng also shuffled assets out of the reach of its bondholders ahead of its bond delinquency. That was an eerie echo of the accusation against Huachen that it had done the same with its 30% stake in Hong Kong-listed Brilliance China Automotive Holdings.
Beijing initiated a massive deleveraging in 2015 to curb excessive borrowing by local governments, financial institutions and businesses. As a result, any ticking debt time bombs within private companies have been identified and for the most part, defused. There have been defaults, and will continue to be, but not on a scale that would threaten the bond market.
The same is not true of state-owned enterprises, who are are thought to account for more than half of the nearly $4 trillion corporate bond market. Huatai Securities has calculated that the default rate for Chinese private companies rose sharply to 5.34% in 2018 from 1.83% in 2017, but defaults by state-owned enterprises remained at 0.02%.
Ten state-owned enterprises have defaulted on bonds worth a total of 54 billion yuan so far this year (out of a total of 109 corporate bond defaults), compared to 25 over the past five years, on a total of 156.8 billion yuan of bonds. This month and next could be rocky as state-owned enterprises are at risk of year-end cash crunches.
People’s Bank of China Governor Yi Gang wrote in the middle of this month that investors have to take on more risk as China moves away from implicit guarantees of the government backstopping state-owned enterprises’ debt.
For bondholders, that is coming as an unpleasant surprise — or rather a series of them.