On Monday, in “China May Double Down On Debt Swap As ABS Issuance Stumbles [8]”, we reiterated the important point that China is effectively pursuing a number of competing policy goals in an attempt to deleverage and re-leverage simultaneously.
The effort to rein in shadow banking (deleveraging) has led to slowing credit creation just as economic growth decelerates, a decisively undesirable scenario that multiple policy rate cuts (re-leveraging) have so far proven ineffective at ameliorating. Meanwhile, a push to make it easier for banks to securitize loans and thus free up their balance sheets for more lending (re-leveraging) has been complicated by rising NPLs and Beijing’s apparent willingness to let the free market play more of a role in deciding which companies default (deleveraging).
Over the past several months we’ve seen at least three examples of Chinese defaults including Baoding Tianwei Group [9], a subsidiary of state-owned parent China South Industries, and while creditors have asked China South to guarantee the notes, the mere possibility that Beijing will begin to take a more hands-off approach when it comes to propping up borrowers (especially state-owned borrowers) has some lenders nervous. This was on full display on Monday when duck processing company Zhongao defaulted citing banks’ unwillingness to roll its debt.
FT has the story [10]:
A profitable Chinese duck processing company has defaulted on its debts after banks refused to roll over its loans — in a sign of lenders’ wariness over refinancings as China’s economy slows.
Until recently, Chinese banks have been reluctant to write off big debts, preferring to keep businesses alive by rolling over their loans. But privately owned Zhongao has cited banks’ tighter lending policies as a reason why it lacked the funds to repay Rmb282m ($45m) in principal and interest despite turning a profit last year.
It has now defaulted on debt from 13 banks, and warned it may not be able to repay Rmb200m in bonds maturing on June 12.
If it fails to pay its bondholders, it will add to a series of recent defaults in China’s bond market where — until recently — many investors had assumed the government would not allow them to take losses.
Underscoring how much things have changed, Zhongao was actually a profitable company, unlike Baoding Tianwei, for instance, which incurred large losses in 2014.
Unlike other defaulters, however, Zhongao remains profitable, according to its latest financial statements. It made a net profit of Rmb388m in the first nine months of 2014, up 42 per cent over a year earlier. In late April, though, the company said the release of its fourth-quarter 2014 and first-quarter 2015 results would be delayed.
In the past, Beijing would pressure banks to roll over bad debt in an effort to paper over problems and keep NPLs artificially suppressed at the country’s large lenders and indeed, that practice looks likely to continue especially for local governments who will enjoy lenient treatment should they run into trouble on any new debt incurred through the use of LGFV financing for ongoing projects.
It’s now a different story for private companies however. Here’s FT again:
But analysts point out that non-state entities such as Zhongao have less clout than state-owned enterprises and local governments to demand that banks roll over their loans. Last month, Chinese authorities ordered banks to roll over loans to local government financing vehicles, even if borrowers were unable to repay principal or interest.
Non-performing loans at Chinese banks reached their highest level in more than five years by the end of March, official data show, and bankers say they are under pressure to curtail risks. Local media has reported that many branch managers’ pay is now directly linked to their NPL ratio.
One would certainly expect this trend to continue because as noted last month [11], some 40% of credit risk in China is carried outside of traditional loans, but even if you take the figures at face value (which, again, one absolutely should not, especially as it relates to NPLs in China), the picture is not pretty.
[12]
