Defaults send jitters through bond market

Under the government's efforts to deleverage markets, are credit defaults likely to become part of the "new normal?"

Investors in the Chinese bond market are growing increasingly concerned about the rising number of defaults, amid fears that the trend may extend into the second half of this year.

As of May 25, about 20 bond issues by more than 12 companies were in default, according to Chinese financial data provider Wind Information. The defaults, involving more than 16 billion yuan (US$2.5 billion) of debt to date, spiked in April and May.

Among the defaulters, Liuzhou Chemical Industry Co, a fertilizer maker owned by a local government, and six other companies were added to the list this year.

The present wave of defaults comes amid a more fluid interbank money market, which mirrors some structural problems, according to CIB Economic Research & Consulting.

“Some enterprises have rapidly increased their leverage even amid regulatory policies trying to control leverage rates,” wrote CIB Research analysts He Jinjin, Guo Yuwei and Lu Zhengwei. “At a more macro level, the defaults may be a reflection of strictures on broad financing channels.”

Freddy Wong, fixed-income portfolio manager at Fidelity International, blamed the recent defaults on companies that can’t issue new bonds to pay old debts and on banks canceling their stand-by lines of credit.

In 2014, the Chinese bond market suffered its first default. Since then, more than 50 private companies have been a risk of failing to service debt obligations.

Unlike corporate bond defaults in 2016, when breaches mainly appeared in industries like coal and steel that were suffering profit declines, the more recent round involves many companies with steady fundamentals.

The recent defaulters this year are mainly private companies, many of which are listed and have been regarded as sound businesses with lower risks.

Wind Information data show about a quarter of outstanding loans in the 76.97 trillion yuan bond market will come due within a year, and 15 percent will mature this month.

Under the government’s efforts to deleverage markets, are credit defaults likely to become part of the “new normal?” That questions haunts investors.

As the government tightens the screws on shadow banking, it should not come as a big surprise that firms with poor creditworthiness may go under, according to a report by UBS Securities.

“Financial instability caused by deleveraging is unlikely, however, for it defeats the very purpose of the proactive deleveraging policy — that is, to reduce risks in the system,” said Gao Ting, head of China Strategy at UBS Securities.

“After the recent economic recovery, we also think corporates are now on a better footing to service debt,” Gao added. “A-share non-financial companies, for example, had an aggregate interest coverage ratio of six in 2017, substantially higher than four in 2015.”

Fidelity’s Wong noted that the Chinese central bank steered clear of using the word “deleveraging” in its monetary policy report for the first quarter of 2018. It preferred the term “structural adjustment.”

“The wording sent an important policy signal that government regulatory focus has turned to readjustment of resource allocations and capital flows between various industries,” Wong said. “With the new rules and regulations on asset management that were released recently, the bond market may be helped to return to fundamentals in the second half of this year.”


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