A China debt default raises question: Will officials always step in for companies allied with local authorities?

A Chinese state-backed borrower’s failure to make good on a payment on a dollar bond on Friday threatens to overturn assumptions that officials would step in to avert defaults by companies closely linked to local authorities.

Qinghai Provincial Investment Group, an aluminum producer that was seen by some analysts as a bellwether for assessing government support due to its struggles to make payments on offshore debt last year, had failed to wire funds for a coupon payment due February 22 as of late afternoon China time. That was according to an official at QPIG, as the issuer is known, who asked not to be named citing company policy. There is no grace period for a missed coupon on this note, according to the bond prospectus, suggesting it’s now in default.

As recently as mid-December, S&P Global Ratings had removed QPIG from CreditWatch with negative implications, concluding that it would “continue to receive ongoing government support and be able to meet its short-term financial obligations over the next 12 months, despite its weak liquidity.” S&P rated QPIG at B+, four steps below investment grade.

While discussions have been taking place to shore up QPIG, based in the western province of Qinghai, Friday’s failed payment indicates limits to officials’ appetite to aid borrowers with high leverage in industries with excess capacity. Though China’s national policy makers have unveiled a slew of measures to support economic growth in recent months, the Communist Party’s senior leadership reaffirmed at a Politburo meeting Friday that addressing financial risks remain a priority for 2019.

Investors appeared to not have seen the coupon-payment failure coming, with prices on QPIG’s $300 million bond due in 2020 indicated around 94 cents on the dollar before Bloomberg reported the news on Friday. Some analysts regard the company as a local government financing vehicle, and the apparent default may renew predictions for LGFV defaults that HSBC Holdings Plc analysts said just last month was unlikely in the short term.