Analysis: China’s bond defaults show Beijing’s debt war is back

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SHANGHAI / SINGAPORE (Reuters) – A wave of missed debt repayments by three Chinese state-owned companies – a coal miner, a chipmaker and an auto company – has rocked local markets and heightened speculation that a campaign to weaning the economy off heavy credit is backwards.

The defaults have angered investors, who say their confidence in the blue chip ratings of companies, seemingly healthy finances and implicit state support has been violated.

While the noticeable lack of state support for struggling state-owned enterprises suggests that Beijing now has more confidence in the economy’s ability to absorb such failures, it has caught many bondholders off guard.

A default at the end of last month by Huachen Automotive Group Holdings Co, the parent company of Chinese joint venture partner of German automaker BMW, illustrated opaque risks, underdeveloped pricing mechanisms and investor naivety about the Chinese corporate bond market.

“If the company had told investors it was in big trouble, I wouldn’t have bought and held the bonds,” said Shanghai-based hedge fund manager Vincent Jin, who bought Huachen bonds early on. of this year.

Huachen boasted of an AAA issuer rating when it launched its three-year 1 billion yuan ($ 151.93 million) private bond in October 2017. , lots of land and backing onto the state.

Creditors were therefore stunned when Huachen not only defaulted, but was also taken to court by a creditor for bankruptcy restructuring.

Additionally, a month before its bond default, Huachen transferred its 30% stake in Hong Kong-listed Brilliance China Automotive Holdings Ltd to a subsidiary, leaving bondholders without access to those assets.

Jin missed the warning signs in Huachen’s books. At the end of 2019, the company had 144.8 billion yuan in liabilities – mostly short-term – three times the interests of shareholders. With the exception of BMW, all of Huachen’s auto brands were bleeding money.

As rumors circulated about Huachen’s problems, Jin didn’t cut his losses, assuming the government wouldn’t let a heavy state-owned enterprise fail.

BACK TO NORMAL

For some, such flaws suggest that credit markets are simply picking up where they left off last year, before COVID-19 crippled the economy and as the Communist Party waged a war on debt and unproductive investments.

“It’s really more of a message than anything, and unless there is a threat to China’s financial or economic stability, the central government is happy to let state-owned enterprises go bankrupt.” , said Andrew Collier, CEO of Orient Capital Research. “Obviously, the central government is unwilling to intervene and now basically tells local governments that they are on their own. “

For investors, this leaves big questions about the changing risk profile of SOEs and their relationship with the state.

In central Henan Province, Yongcheng Coal & Electricity Holding Group Co, an AAA-rated public mining operator, defaulted on November 10, just three weeks after issuing new debt and a week after moving its stake in Zhongyuan Bank to two government branches.

State enterprise defaults are nothing new, but preventing bondholders from having liquid assets is, said Rocky Fan, an economist at Sealand Securities.

“It’s like telling investors, I don’t want to give your money back,” Fan said.

“If that’s the case, there’s no way to assess a company’s risk or to price a bond based on its fundamentals.

Yongcheng’s 270-day commercial paper carried a 4.39% coupon, well above the risk-free rate of 1.84% on government debt at the time of issuance, but “still low given the risks.” , said a manager of a local brokerage house.

In another case, Tsinghua Unigroup, a chipmaker backed by the prestigious Tsinghua University in Beijing, defaulted on a three-year 1.3 billion yuan bond on November 15, shortly after a rating agency had called it. warned against the risks of indebtedness of the company.

The defaults sent other bonds issued by Yongcheng, Huachen and Tsinghua Unigroup to about a tenth of their face value.

“For too long (the risk) has been misjudged. This is what a misallocation of capital looks like, ”said Fraser Howie, independent analyst and co-author of“ Red Capitalism ”.

“You’ve invested money in businesses that just don’t deserve it. “

QUICKSANDS

Over 90% of rated Chinese issuers have stamps of AA or higher. This lack of differentiation has complicated efforts to assess risk.

“Most sophisticated investors understand that there is a major difference between lending to a public company and lending to the government,” said Michel Lowy, founder and CEO of SC Lowy, a global banking and management group. assets focused on struggling companies. and high yield debt.

“(This) is a quick reminder of the difference and that China does not intend to bail out all state-owned enterprises that have made bad choices.”

Huachen bondholders say the automaker’s sudden default could have been complicated by local politics.

Two months before Huachen’s default, Liu Ning, former governor of Qinghai province, was appointed governor of Liaoning, while Zhang Guoqing, former mayor of Tianjin, became provincial party secretary. The two leaders implemented significant restructuring in their former jurisdictions, both of which were heavily indebted.

It’s dangerous ground that most foreign investors, even risk-loving ones, avoid.

“For us, as fundamental investors, this is not a market to play in,” said Tiansi Wang, senior credit analyst at Robeco in Hong Kong. She said the defaults are a good sign nonetheless.

“It’s not healthy if no one ever takes the pain – then you don’t have an appropriate risk pricing environment.”

($ 1 = 6.5818 Chinese yuan)

Reporting by Andrew Galbraith and Samuel Shen in Shanghai and Tom Westbrook in Singapore; additional reporting by Rong Ma in Beijing; Editing by Vidya Ranganathan and Sam Holmes

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