China faces another default wave from companies in 2016
Weak underlying demand and overcapacity issues may trigger a cluster of credit events
China’s credit market risks will likely persist throughout this year as a potential corporate default wave could trigger a short-term credit crunch, analysts said.
Defaults may be due to weak underlying demand in the economy and overcapacity issues in overcrowded sectors. They could cause companies to have to pay more to borrow, adding to their debt.
In particular, sectors that struggle with excess capacity, such as steel, cement and coal mining industries, may suffer the most, analysts said.
“Until more serious debt restructuring takes place, the risk of one, or a cluster, of default events triggering another credit market sell-off remains, even if that is not our base-case,” UBS analysts said in a recent research report.
The Chinese bond market — where companies issue notes at a rate of interest to borrow money — has recently entered the peak season for defaults. In total 40 bond issuers have announced the risk of default as of the end of April, according to Deutsche Bank. It assessed over 50 bonds with an aggregate principal of over 60 billion yuan.
China Chengxin International Credit Rating has downgraded bond issuers at least 33 times as of the end of April. That’s almost double the 17 times in the same period in 2015.
As credit events increased, the primary market has notably shrunk. The issuance of 103 bonds with an aggregate principal amount of 100.9 billion yuan have been delayed or cancelled as of end-April, according to Deutsche Bank.
Additionally companies that planned to issue 57 bonds to borrow 51.3 billion yuan have delayed or cancelled their issues on the inter-bank market, the German investment bank said.
“More credit risk events, such as postponing or defaulting on debt repayment, are emerging in China, on the back of a fast growing debt overhang, accumulating excess capacity issues, rising debt-servicing costs, and deteriorating bank asset quality,” UBS analysts said.
“The recent credit market sell-off, a spate of defaults, a spike in Chinese yields and spreads, bond issuance cancellations at root reflect a re-pricing of perceived credit risk and expectations (for less policy easing),” they added.
As the People’s Bank of China, the country’s central bank, signalled the end of overtly-loose monetary policy, markets started to price in “no more monetary easing” from the end of March, UBS analysts said.
The PBOC’s monetary policy management, coupled with a large number of tax payments, have caused the seasonal quarter-end liquidity tightness in the first quarter to “spill over” into early second quarter, they said.
Besides that, an increased supply of local government bonds, a growing number of defaults, issuers adapting issuance plans to a higher yield environment, and a rise in investor redemptions on asset management accounts have all heightened investors’ fears and triggered the recent turmoil in debt markets.
Looking ahead, the pressure on credit markets will likely persist to varying degrees and more credit events will emerge, UBS analysts predicted.
An increasing number of credit/rate products will mature in the next few quarters, given the rapid growth of short term commercial papers in the previous year, most of which may need to be rolled over or allocated fresh funding, they said.
Coupled with “fragile underlying demand and slow excess capacity resolution,” the risk of further credit/default events emerging is growing, they said.
In particular, analysts from Deutsche Bank said capacity-burdened industries are likely to face higher default risks.
So far, negative events in the bond market have been concentrated in the sectors of steel, cement, coal mining, chemicals, non-ferrous metal and ship-making.
“Those industries are either cyclical in nature or facing the issue of overcapacity,” the Deutsche Bank analysts said.
Additionally the tendency of default among small and medium enterprises has also increased since late 2015 or early 2016.
“Although these (defaults) were ultimately resolved via payments guaranteed by a third party and (did) not constitute as a default technically, to these guarantee-providers, their risks of payment are increasing,” said analysts from the German bank.
A potential default wave could have spill-over risks, according to analysts from UBS.
Those risks include a bigger-than-expected loss of confidence in China and other shadow credit markets, such as equities and trust products and a possible overall credit crunch for the wider economy.
That being said, a systemic risk for either China’s bond market or overall credit system is still unlikely, as the Chinese economy is not reliant on corporate bonds for new credit but instead rely on bank loans and local government bonds. Also the Chinese central bank still has ample capacity to stabilise money market rates via additional liquidity provisions, they said.