China Bond Buyers Blacklist Provinces After Run of Defaults

(Bloomberg) -- Investors are becoming more discerning when it comes to the origin of Chinese debt.

China saw its worst start to a year on record for corporate defaults, with companies headquartered in two eastern provinces -- Liaoning and Shandong -- responsible for the lion's share. Money managers are taking notice, with a run of messy, high-profile company scandals helping sour sentiment toward certain regions. Beijing's de-leveraging drive, which has been ramped up this month and has boosted borrowing costs, is also a factor.

“When the whole bond market is under pressure amid regulatory checks, investors would certainly want to sell those in risky regions first,” said Nie Wen, an economist at Huabao Trust Co. in Shanghai, which managed 557.5 billion yuan ($81 billion) at the end of 2015. “As the liquidity tide starts to ebb, it's time to see who's swimming naked.”

A lot of institutions active in China's corporate bond market have a “watch list” of regions they're wary of, Nie said. For many investors, which province the issuer is based in is second only to monetary policy when it comes to buying debt.

“With collateral and guarantees so important in the credit world, being in a troubled place means the spillover effect could bring problems to firms which are fundamentally healthy,” he said.

The slowest-growing of China's 31 provinces, Liaoning hasn't been far from the headlines this year, with officials in the rust-belt region admitting to falsifying fiscal numbers for years. In the past, the bond market has ignored differences in provinces' risk profiles on bets Beijing will step in if they have trouble repaying liabilities, but that may be shifting.

Click here for a deep dive in to the economy of China's worst-performing province.

The Liaoning government paid the most this year to issue bonds last week, while Tieling Public Asset Investment and Management Co., one of the province's financing vehicles, failed to sell dollar debt offshore in November. The yield on Liaoning's five-year notes rose one basis point on Thursday to 4.03 percent.

Huishan Dairy

Liaoning is also the home of China Huishan Dairy Holdings Co., the Shenyang-based milk company which rocked the Hong Kong equity market last month when its shares suddenly plunged 85 percent following an emergency meeting with creditors. Dongbei Special Steel Group Co., too, hails from Liaoning. The steelmaker, from Dalian on the Yellow Sea, was China's top defaulter last year, missing repayments after its chairman was found dead by hanging.

The Huishan Dairy case reverberated beyond its home province, with shares of Jilin Jiutai Rural Commercial Bank Corp., the company's second-largest creditor, tumbling in Hong Kong on concern over the impact on its assets. The lender is based in Jilin, which neighbors Liaoning to the north.

In Shandong -- where two of last quarter's seven corporate defaulters are headquartered -- local company Xiwang Foodstuffs Co. saw its stock suspended on concern over a decision by its controlling shareholder, Xiwang Group Co., to guarantee liability for Shandong-based aluminum producer Qixing Group Co.

“It's not about prejudice when investors have geographical preferences,” said Li Yulong, chief investment officer at Jyah Asset Management Co. in Shanghai, which oversees 40 billion yuan. “The reality in China is that local governments are inextricably interwoven with local companies. History shows the default frequency in different regions varies.”

China's three northeastern provinces have higher government debt ratios, meaning they could be harder hit by the tightening in bond and money markets, said Nie at Huabao Trust.

“For those regions that don't have solid economic fundamentals, we'll avoid the whole area,” said He Qian, who manages the $895 million Fortis Haitong Pure Bond Fund at HFT Investment Management Co.'s. The fund beat 84 percent of its peers over the past year.

Earliest data show growth in China's economy may be cooling slightly, while capital flowed out of the nation last month after a respite in February.

As part of a wider de-leveraging campaign, regulators have been upping controls in the banking sector this month, renewing pressure on the bond market. An index of Chinese debt compiled by Bank of America dropped 0.5 percent last week, the most since a December selloff spurred by tightening in the money markets. President Xi Jinping also announced a comprehensive check of financial markets after a meeting with the Communist Party's politburo on April 25.

China is cracking down on financial risk -- click here for a QuickTake Q&A.

Colight Asset Management Co. is avoiding provinces where companies have borrowed heavily to repay existing debt.

“For riskier regions, internally we require stronger operating cash flow or other indicators that prove they have a particularly strong refinancing ability compared with other companies in the region,” said Xu Hua, head of research at Shanghai-based Colight, which manages more than 30 billion yuan. “Credit events will make it a lot more difficult to refinance.”

--With assistance from Hannah Dormido

To contact Bloomberg News staff for this story: Helen Sun in Shanghai at hsun30@bloomberg.net, Ling Zeng in Shanghai at lzeng30@bloomberg.net.

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Christopher Anstey at canstey@bloomberg.net, Emma O'Brien, Robin Ganguly

With assistance from Helen Sun, Ling Zeng