China debt: bond problems could still resurface in 2020 after defaults amid coronavirus lower than expected
- Bond defaults have dropped 26 per cent from a year earlier, but a larger increase was expected due to the economic damage caused by the coronavirus
- Value of defaults rose almost 40 per cent to 64 billion yuan (US$9 billion), although more than half came from one case involving the state-owned Founder Group
Problems in China’s corporate bond market could still resurface later in the year after the level of defaults did not surge as high as expected during the economic downturn caused by the coronavirus outbreak thanks to ample credit and relaxed issuance requirements.
The world’s second largest bond market after the United States has recorded 71 default cases so far this year, according to financial database Wind, 26 per cent lower than a year earlier.
The value of missed repayments on corporate bonds rose almost 40 per cent to 64 billion yuan (US$9 billion), although more than half came from one high-profile case involving the state-owned Founder Group. The Beijing-based technology firm, established by China’s top-tier Peking University, has so far defaulted on 36 billion yuan of bond payments this year in the process of restructuring its debt.
Among private bond issuers, the total value of defaults has dropped 46 per cent to 23 billion yuan so far this year.
In the wake of the coronavirus pandemic, the small increase in the default risk has surprised some analysts, since the sharp drop in profits of many companies in the first quarter of 2020 would suggest they would run into trouble paying off their debt. Instead, defaults have not increased significantly, and new bond issuance have actually increased.
“All of this has happened without the People’s Bank of China directly buying corporate bonds, as the US Federal Reserve and European Central Bank have done. This is surprising since the strains in China’s corporate bond market had intensified before the outbreak, with rising defaults and widening spreads [of risky premiums over risk-free treasury bonds] for private-sector issuers,” said Zhang Xiaoxi, a China finance analyst for research firm Gavekal.
“The main reason, however, is that most bond defaults in China are driven by liquidity rather than corporate failures. It was tight financial regulation rather than a poor economy that drove the increase in defaults over the past two years. To avoid a bigger wave of defaults, regulators substantially relaxed the rules for corporate fundraising.”
Bond defaults among private companies surged in the past two years amid the Chinese government’s campaign to contain the expansion of corporate debt in the financial system, particularly loans from unregulated nonbank institutions – so-called shadow banks – that private firms relied on when they were unable to obtain loans from regulated banks due to creditworthiness concerns or weak collateral.
In early February, Beijing relaxed some rules to allow companies to issue bonds to pay off their old debt, leading to a rise in the issuance of what have become known as pandemic bonds.
In addition to easier requirements for new bond issuance, regulators have also been more tolerant with postponing bond repayments to avoid formal defaults. So far this year, there have been 13 payment extensions.
Other companies have employed bond swaps – replacing an old bond with a new one that offers a higher return – which were not commonly used in the past.
While China’s central bank has not eased its monetary policy as much as its counterparts in the US and Europe, its cuts in interest rates so far have lowered the cost of fundraising for private firms through new bond issues.
But analysts said these measures might just be short-term to help firms get through a particularly tough period.
“[The falling defaults are] mostly because of credit easing in the onshore market since the beginning of the year. There is ample liquidity in the market which enables issuers to refinance their debt,” said Ivan Chung, head of Greater China credit research and analysis at rating firm Moody’s Investors Service.
“Having said that, you need to look at the second half [of this year], many [businesses] only refinanced via short-term debt in the bond market. They mainly issued short-term paper, six to nine months, so a few months down the road. I wouldn’t say default risks have disappeared.”
They mainly issued short-term paper, six to nine months, so a few months down the road. I wouldn’t say default risks have disappeared
The large increase in the value of maturing bonds in the second half of the year also increases the risk of default. According to rating agency Fitch, around 772 billion yuan (US$108 billion) of bonds issued by private firms will mature in the second half of 2020, more than doubling the amount in the first six months.
And among the bonds maturing in the second half of the year, almost half were issued by those rated AA+ or lower, meaning they are more likely to default than bonds with higher ratings.
“The amount of money that these low-rated private firms raised from the bond market this year has actually fallen by more than 10 per cent,” said Zhang Shuncheng, an associate director of corporate research at Fitch. “This means that these firms didn’t benefit much from the government’s liquidity support. The biggest beneficiaries were mainly state-owned enterprises and high-rated private firms.”
But as the country opened up its bond market to global investors, defaults have become more of a norm, just like in a developed capital market. However, most are still private firms, which on average face a higher cost of raising capital in the bond market than their state-owned peers.
