China’s Corporate Bond Defaults Unveil Hidden Blind Spots

(Bloomberg) -- China's policy makers have been walking a tightrope between countering the economic damage caused by the Covid-19 crisis and fueling another debt bubble from the latest spending spree.

Since the first onshore bond default in 2014, there have been 395 onshore delinquencies. Of that, 31.9% of the bonds that failed to repay debts were issued in 2016, a boom year for onshore companies raising funds when yields fell as low as 3.49% prior to deleveraging efforts.

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President Xi Jinping's deleveraging campaign in 2016 in a bid to curb risks in the nation's financial markets led to a crackdown on shadow banking and tighter rules on asset management. As a result, firms had a tougher time raising funds to repay existing debt, spurring consecutive record bond defaults in 2018 and 2019. That prompted the government later to seek ways to ease the liquidity crunch.

Here are the four charts that show more details:​​

Bonds that defaulted less than three years after issuance formed the bulk or about 80% of the delinquencies, while 109 notes failed to make payment within one year. That aggravates the default risk when the debtor is unwilling to repay the debts due, even though it has cash flows.

Since the introduction of new corporate defaulted bond recovery guidelines in December, at least a dozen companies have sought to ease or delay imminent debt repayments by issuance rollover, repayment deadline extension, early redemptions cancellation, and over-the-counter repayment.

Earlier this year, Beijing Sound Environmental Engineering Co. became the first in onshore China to complete an exchange offer, but failed to make part of a bond principal repayment due to tight liquidity.

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China's central bank published new rules on Wednesday aimed to improve the mechanism on the disposal of corporate credit bond delinquencies. These new guidelines clarify the role played by bond trustees and meetings with creditors, and seek to making the process more market-oriented and transparent, including the trading of defaulted bonds on qualified platforms, supporting diversified channels, the use of credit derivatives and more information disclosures required.

Energy companies accounted for almost half of 2018 onshore corporate bond defaults, dominated by Shanxi-based coal miner Wintime Energy. Basic materials and consumer sectors were the top two defaulters in 2019, while technology companies leads the delinquencies so far this year.

Comparably, the real estate sector has no share of default action through June this year, with developers having a weighting of 5.2% and 10.3% respectively in 2018 and 2019.

“This is likely the result of a very favorable funding environment and a more controlled pace of expansion for developers. Moreover, some developers may have delayed their property deliveries, as allowed by local governments, thus limiting working capital outflows,” said Zhou Chuanyi, a credit analyst at Lucror Analytics in Singapore.

Read more: Real Estate Woes Mean China Has New Locus for Credit Stress (1)​

Beijing ranks the first among all the provinces with total defaults of 75.3 billion yuan since 2014, followed by Shanghai and Zhejiang. Xinjiang, Tibet, Shaanxi, Jiangxi and Guizhou are the bright spots for investors, maintaining a clean sheet of repayment capability. ​

Similar to the onshore market, energy firms dominated offshore delinquencies in 2018 with a share of 66.8%, mainly coming from defaults of $1.8 billion by China Energy Reserve & Chemicals Group Co. Distribution and wholesale sectors accounted for 32.3% of the offshore defaults in the subsequent year, driven by Tewoo Group's distressed exchange.

Since the start of the year, Peking University Founder Group Corp., the troubled business arm of a top Chinese university, has contributed 35% of the total offshore defaults, pushing technology industry to top all sectors.

Tewoo Group Co. and Qinghai Provincial Investment Group Co. became the two biggest dollar bond defaulters among the nation's state-owned companies in two decades. Founder Group, with vague and questionable support from the state, has joined the list lately.

Read more: At Least 69 Chinese Companies Face Debt Repayment Pressure

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