Strains showing for China's indebted firms
After Chaori's bond default, warning signs are flashing for other mainland companies that the government appears reluctant to bail out
Credit warning signs are flashing for heavily-indebted mainland semiconductor, software and commodities companies as the government cautiously steps aside to let market forces play a bigger role in deciding winners and losers.
The mainland's first domestic bond default this month - a missed interest payment from Shanghai Chaori Solar Energy Science and Technology - shattered the belief that Beijing would always bail out struggling firms.
"The Chaori default goes to show the government will begin to let the market decide the fate of weak borrowers," said Standard & Poor's analyst Christopher Lee in Hong Kong.
Lee said defaults would be "incremental but controlled" with sectors including shipbuilding, metals and mining, and materials among those showing the highest risk as China's economic growth slows and banks tighten lending.
Mainland companies owe just over US$1 trillion in domestic bonds, of which 15.8 per cent is coming due this year.
While firms are confident they could obtain credit, domestic rating agencies have stepped up the pace of downgrades. There were 77 companies downgraded in 2013, more than triple the previous year's tally, according to ratings agency China Chengxin.
A Reuters analysis of more than 2,600 Chinese companies found credit metrics worsening across a range of industries. The software sector was shouldering the heaviest credit burden with an average of 3.4 times more debt than equity. Semiconductors - a category which includes solar companies such as Chaori - had a debt-to-equity ratio of 2.6.
Across all listed Chinese companies, the average debt-to-equity ratio was 0.85 in 2013, according to Standard Chartered.
It is unclear where Beijing will draw the line on letting market forces prevail. Premier Li Keqiang said on March 13 that Beijing was "reluctant to see defaults of financial products but some cases are hard to avoid".
But social stability has traditionally trumped market reforms. If a major employer or a high-profile company were to slip into distress, the government is all but certain to intervene. The municipal government of Wuxi, for example, threw a US$150 million lifeline to struggling solar firm Suntech Power in October.
Local governments will be keen to protect companies that are important taxpayers and employers, but would be willing to let smaller ones like Chaori fail, according to a Hong Kong-based analyst with a US bank, who declined to be identified.
Materials firms look vulnerable as weak commodity prices hurt profitability, leaving less money to repay debt. Although the metals and mining sector's average debt-to-equity ratio is a manageable 1.4, bondholders see rising risk and have demanded higher yields for holding the debt.
Xinyu Iron and Steel, for example, would need almost 18 years to repay its total debt at the present rate of cash generation. Its bonds due in 2016 saw yields rise 160 basis points this month alone to around 10 per cent.