China’s smaller companies face credit challenge as bond market funding dries up

Fund raising platform on the Shanghai Stock Exchange geared towards un-listed companies has not recorded a single debt deal this year

PUBLISHED : Thursday, 12 May, 2016, 9:01pm
UPDATED : Thursday, 12 May, 2016, 9:10pm

Small mainland Chinese companies, struggling to keep stay afloat amid the cooling economy, have suffered a setback as the high-yield corporate bond market on the Shanghai Stock Exchange appears to have swung shut with investors, spooked by fears of rising defaults, have shied away from the debt sales.

Not a single high-yield bond offering has transacted on the Shanghai Stock Exchange so far this year, a fundraising and trading platform slated for medium and small-sized unlisted firms.

Institutional investors, underwriters and companies said that the rising number of defaults on the country’s 14.3 trillion yuan bond (HK$17.03 trillion) market recently and expectations of a credit crisis have undermined the junk debt market.

“The door has been shut for those small firms,” said Shenwan Hongyuan Securities chief bond analyst Chen Kang. “It is unlikely that the fundraising platform could be reopened anytime soon.”

In mid-2012, the China Securities Regulatory Commission (CSRC) established the market at the Shanghai bourse, creating an alternative to banking loans for small- and medium-sized firms.

Companies are allowed to conduct sales of the high-yield debt through private offerings before the bonds are listed on the Shanghai exchange.

It was seen as a ground breaking move on the mainland’s corporate debt market because only large-size industrial or financial juggernauts with higher ratings could sell debt on the interbank bond market and the exchange before the liberalisation.

Beijing has been striving in the past decade to develop the bond market to help businesses access much-needed funds for expansion.

But a worsening business environment arising from a slowing economy, weaker external demand and overcapacity in certain heavy industries since 2015 has triggered more than 20 bond defaults by mainland companies.

Small companies would have to offer more than 10 per cent annualised interest rates to attract buyers, a lofty interest rate that few firms can afford amid lacklustre profitability.

“In the face of a slower economy and thin profit margins, it doesn’t make sense to borrowing money at such a high cost,” said Tian Gang, a Shanghai entrepreneur running a financial service firm. “What’s worse, the worries about small companies’ repayment ability seem to have a devastating psychological impact on the bond market.”

Three officials with underwriters and rating agencies said that institutional investors have decided to shun the high-yield debts as a way to minimise risk.

China’s bond market encountered its first default on March 2014 when Shanghai Chaori Solar Energy Science & Technology failed to make an interest payment.

A wave of bond defaults including repayment failures by state-owned businesses occurred this year, exacerbating bearish sentiment on the bond market.

China Railway Materials, the nation’s largest railway materials distributor and one of its largest steel products traders was among the troubled firms struggling with debt obligations.

Analysts said the repayment issue involving Railway Materials had the potential to trigger a crisis of confidence.

According to Reuters, 150 bond issuers expected to raise 154 billion yuan were cancelled on the mainland bond market in April.

In the first week of May, an additional 17 companies abandoned their debt-raising plans.

“The bond market is closely related to the country’s credit system,” said Gu Weiyong, chief executive of Shanghai Ucon Investments. “As the bond market is set to see more defaults in the coming months, the regulators and state-owned parents will have to step in to avoid a potential crisis.”

Beijing has urged state companies to kick out zombie firms – habitual loss makers saddled with overcapacity, a move likely to increase the number of defaults with governments and state-owned parents refraining from bailing out the embattled debtors.

Mainland leaders have also pledged to maintain financial stability, saying that interventions would be made to stop systematic and regional risks from arising.