The Strategist

Record number of corporate defaults is coming to China

06/12/2018 - 04:28

The number of defaults on corporate bonds in China is expected to reach a new high in 2018 amid tightening of measures within the framework of Beijing's debt reduction program. This is reported by Caixin.

Mstyslav Chernov
Mstyslav Chernov
"The risk of default has grown because of more stringent regulation, and investors should be fully aware of the possibility of a vicious circle caused by the credit crisis and the deterioration of confidence in the market, which will lead to further defaults," said the head of China Chengxin (Asia Pacific) Credit Ratings Yan Yan.

The risk of default is particularly high due to the large number of bonds with a maturity in 2020, says Yan. In total, the maturity of the bonds will amount to 5.68 trillion yuan by the end of this year. In 2019, the maturity of the bonds with total volume of 3.86 trillion yuan will come in addition to those already mentioned, and in 2020 the figure will reach 3.66 trillion yuan.

Analysts warn of the negative consequences of a policy to reduce excess leverage, which ultimately should improve stability of China's financial system. Investors should also beware of the side effects of such a policy for the offshore bond market, experts say.

"Some of these side effects have already occurred. Private oil company China Energy Reserve and Chemicals Group announced in a message to the Hong Kong Stock Exchange on May 25 that it will not be able to make a scheduled payment for its bond by $ 350 million, citing a liquidity crisis, writes Caixin - The default triggered fears of further defaults, as the company said that the missed payment could cause cross-defaults on five other off-shore debt securities."

Earlier, Bloomberg reported that there have been 14 defaults on corporate bonds on the market since the beginning of the year.

"New defaults on bonds are especially likely among those developers and LGFV, who relied on shadow banking mechanisms for their financing," - warned the research company Rhodium Group. LGFV (local government financial vehicles) are firms, affiliated with local authorities and used for their financing.

Increasingly more Chinese companies are concerned about tightening credit conditions, which leads to an increase in borrowing costs and a gradual growth in defaults on corporate bonds.

The People's Bank of China previously announced that it would accept corporate bonds with a lower rating as collateral for medium term lending (MLF) operations. According to analysts, in part this decision is aimed at restoring confidence in the country’s market of corporate bonds.

The expansion of collateral for MLF "will calm the market, but we still expect individual defaults, especially for companies with weak finances, as the reform aimed at reducing debt in the financial sector continues," notes ING economist Iris Pang, quoted by Reuters.

Beijing will do everything possible to avoid massive defaults, but another risk is that a negative mood towards Chinese corporate bonds may become a negative factor for the debt of emerging markets. This could lead to an even greater outflow of capital from emerging markets and new complaints from central banks of developing countries, asking the US Federal Reserve to end the tightening of policy.