The ongoing outbreak of coronavirus in China has put pressure on Chinese corporates especially SMEs. Facing a shortage of cash flow due to drops in domestic consumption, issuers in related industries with weaker liquidity are expected to see accelerated bond defaults in 2020.
“The fear of contagion could dampen consumer demand, and affect tourism, travel, trade and services in affected countries. The burden on healthcare sectors in affected countries would also potentially increase,” notes Atsi Sheth, managing director, Moody’s Investors Service.
China has already had the first onshore bond default in 2020 in the exchange market. Dalian Zeus Entertainment, a Shenzhen-listed company, failed to repay the principal and interest for its one-billion-yuan (US$140 million) bond due to its liquidity issues. The credit bond has a five-year tenor and investors have a call option exercisable at the end of year three.
In 2019, over 170 onshore bonds had defaulted in China, amounting to over 120 billion yuan. It is widely expected that the number of defaults will continue to increase in 2020.
“The default rate in China is unrealistic from a global market perspective. Some degree of credit differentiation and some defaults to impose discipline in terms of credit selection are a norm for global credit market. China is going through that phase in the credit market,” says Desmond Soon, head of investment management, Asia (ex-Japan) at Western Asset Management.
As China continues to open its capital markets, international investors have been increasing their allocation in China’s bond market due to a higher yield. Data from China Foreign Exchange Trading System shows that China’s interbank bond market saw a 1.1-trillion-yuan net inflow from overseas investors in 2019. As of last year, the total foreign holdings of onshore renminbi bonds amounted to 2.19 trillion yuan.
While most international investors still favour China government bonds, some distressed debt investors such as Oaktree Capital and Bain Capital see the distressed debt market as a big opportunity. In January, Chinese media reported that Oaktree Capital will be the first foreign asset manager to be granted a distressed debt license in China.
Meanwhile, China has been strengthening investor protection in the onshore bond market since it started to allow onshore bond defaults.
On December 27 2019, the National Association of Financial Markets Institutional Investors issued a disposal guidance on bond defaults. In the guidance, the definition of default is similar to that used in international markets.
In a bid to protect investors, in post-default negotiation, issuers are encouraged to impose credit enhancement, repayment guarantees, binding agreements, and changes of controlling stakes. In post-default arrangement, issuers are advised to conduct asset disposal, liquidation, asset and debt restructuring, or introduce strategic investors.
Debt restructuring includes the adjustment of payment terms, liability management and other alternative ways to repay the debt. Issuers are prohibited from transferring assets, hiding assets, creating fraudulent debt, increasing guarantees to external parties, and increasing investment.
In the exchange market, China’s Shanghai Stock Exchange and Shenzhen Stock Exchange established a credit transfer system in 2019 which allows investors to transfer their default bonds to the others.
In 2019, 136 default bonds were transferred on the two exchanges with a total notional value of 6.1 billion yuan. It is expected that the interbank market will offer similar bond transfer services from February 2020.
“These defaults are not spiralling into systemic risk in China. A widespread [wave] of defaults is not likely to happen in China,” says Soon.