Will China Let More Corporate Bond Issuers Default? Overcapacity and depressed prices threaten many of the country’s corporate borrowers, who have gorged on debt for six years

March 18, 2014
CFO.com | US
Will China Let More Corporate Bond Issuers Default?
Overcapacity and depressed prices threaten many of the country’s corporate borrowers, who have gorged on debt for six years.
Vincent Ryan
Are Chinese corporate debt markets headed for a big fall? First there was the bailout of China Credit Trust Co., followed by the first default in China’s onshore bond market, by Shanghai Chaori Solar Energy Science & Technology. Now, Chinese banks are reportedly cutting lending to certain corporate sectors by as much as 20 percent, according to a story in Reuters, and there are more jitters in the $1.5 trillion (9 trillion yuan) bond market.

The disruption in corporate debt is connected to the surplus capacity in many of the country’s industrial sectors, like steelmaking, and the enormous amounts of credit granted to businesses that invested in fixed assets. As part of the effort to restructure China’s economy to be consumer- rather an export-driven, the government has been trying to separate the wheat from the chaff in industries such as steel, cement, aluminum smelting and shipbuilding.
“China’s cabinet, the State Council, has said that credit must be cut to these sectors and that no new project approvals are allowed until 2017,” Reuters reported last week. The story also said some steel mills were informed by their bankers this month that their 2013 credit limit would be cut by 20 percent.
Chaori Solar’s failure to make a bond payment is stoking speculation that other companies in industries facing overcapacity may do the same, according to Bloomberg. China’s onshore corporate bond market has exploded the last few years, jumping from 800 billion yuan in 2007. “The absence of risk explains a good deal of this surge in corporate debt issuance,” according to Quartz. With no corporate bond defaults, bonds were “unusually cheap,” and banks held bonds until maturity. The question now is whether the Chinese government will truly let the market operate and allow companies to fail.
For example, a closely held Chinese real estate developer with 3.5 billion yuan ($566.6 million) of debt collapsed on Monday, but China’s central bank was reportedly in talks with one of the developer’s largest state lenders, China Construction Bank, to figure out how to repay the company’s debt, according to the Financial Times.
Chinese bond issuers that could face trouble, according to the FT, include XE Flavour, a restaurant chain; Sinovel Wind Group Co.; and Tianwei Baobian, a solar cell maker. A Tianwei bond was suspended from public trading last week after the company posted its second consecutive year of losses, according to the FT. Tianwei, however, unlike Chaori, has a controlling shareholder that is owned by China’s central government.
The “political realities” of China’s financial system are that “Beijing will draw a line between weak private companies and weak government-backed companies; it will let the former default but not the latter,” according to the FT.