Bond defaults in China – is the risk assessment process up to scratch?

The refinancing environment in China continues to be challenging for private sector companies, this comes despite measures to encourage investment in the bond market

Despite liquidity injected by People's Bank of China (PBOC) to the banking system over the past few months, recent corporate bond defaults in China reflect a tight refinancing environment faced by the private sector.

On Nov 5, Chuying Agro-Pastoral Group, a Shenzhen listed pork producer, announced that it was unable to repay the principal and interest of its 500 million yuan short-term bond due on the same day. The issuer announced on Nov 8 that it would pay its interest to bond investors by utilizing its food inventory.

While there is a general consensus among investors that more bond defaults are beneficial to China's bond market in the long term, Chinese financial regulators once again have started to intervene in the market through window guidance to banks amid recent bearish investor sentiment.

"Chinese regulators are facing a challenge in dealing with bond defaults. Issuers who were able to issue bonds in the public market are the top 3000 enterprises in China. If the government did not intervene, the market sentiment would get even worse," says a Chinese regulator in an interview with The Asset in Beijing.

"The government has already introduced regulatory initiatives to encourage investment in the bond market. However, onshore investors seem to expect more incentives," says the regulator.

In China, there is no junk bond or high-yield bond market, as only large issuers, most of which are triple A or double A rated, are able to tap the capital market. Due to the lack of divergence in issuers' credit ratings, investors sometimes failed to tell the real credit quality and the risks of the issuers.

"If you look at those investors who reported loss in those bond default, you will find that they are risk-seeking investors," says a senior executive at a Chinese state-owned bank in an interview with The Asset in Beijing, "This (bond default) is a good lesson for those irrational investors."

According to Wind, 81 bonds from 37 issuers have been defaulted, a value of around 70 billion yuan, as of Oct 15. With regards to the default bonds, regulators and underwriters are working together to assist issuers to liquidate some of their assets, in a bid to pay their investors.

On the other hand, PBoC's expansionary monetary policy did not work as expected. Chinese banks, as a critical intermediary of the financial system, are still cautious and selective in granting loans to privately-owned enterprises (POEs) in light of stricter requirements on their own non-performing loan (NPL) ratios.

As a result, Chinese regulators have been encouraging direct financing channels such as bond market and stock market to Chinese issuers. A policy bank recently told The Asset that National Development and Reform Commission granted more foreign debt quota to local government financing vehicles (LGFVs) and corporates in 2018 while reducing the quota to policy banks, hoping that issuers can tap offshore capital market more, instead of relying on onshore banks.

However, the amount of US dollar bonds issued by Chinese issuers softened in the third quarter, slowing down 23% YOY, according to Lianhe Credit Rating. This is attributable to higher offshore financing costs to Chinese issuers due to renminbi depreciation and higher US dollar interest rates.

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