Lat night we reported that China's bond market was thrown in turmoil after the sudden and very much unexpected default of the recently AAA-rated Yongcheng Coal and Electricity Holding Group, a state-owned mining company in Central China’s Henan province which until last week was seen as sacrosanct due to its explicit government support and which sold debt last month. Well, no more, after 1 billion yuan ($151 million) of the company's bonds defaulted on Friday.
The unexpected default prompted concern over the health of coal firms and their lenders, as well as the broader SOE market in general, triggering a selloff in bonds issued by weaker borrowers from the sector and prompting some of them to cancel debt sales.
The news reverberated across China, immediately setting off a chain reaction affecting other coal mining companies and local government financing vehicles in other provinces. Traded coal bonds plunged, with Jizhong Energy Resources's 5.4% 2021 notes falling 7% to 87 yuan, a record low, while Pingdingshan Tianan Coal Mining’s 5.07% 2023 bond was last trading at 79, just off all time lows.
Local traders were incredulous: "Our investment decision had been based on the belief that triple-A rated state firms are safe investments regardless of their fundamentals,” said the chief ratings officer at a Shanghai-based bond fund. “That’s no longer the case."
Still, some maintained hope that this was a one off event: "The central government won’t allow the situation to deteriorate as that could lead to systemic risks," said a hopeful David Huang, a Shanghai-based bond fund manager who spent 20 million yuan to buy a three-year note by Brilliance Auto for 20 cents on the dollar. "That creates an investment opportunity" he added hoping that the PBOC would do what the Fed did in March and backstop the distressed issuers.
"If they let Yongcheng or Brilliance go under, no state firms in Henan or Liaoning will ever be able to tap the bond market again," said Mr Huang. "The government won’t let that happen."
Perhaps... although as Bloomberg strategist Ye Xie wrote last night, the Yongcheng default inevitably raises the question of who's the next to fall.
We got an answer just hours later, a top Chinese chipmaker and a major car manufacturer announced debt defaults on Monday, expanding a list of distressed state-linked firms that have roiled China’s credit market in recent days.
According to Bloomberg, Tsinghua Unigroup said it wasn’t able to to repay a 5.6%, 1.3 billion yuan ($197 million) privately issued onshore bond due Monday, citing tight liquidity and after failing to win immediate approval from creditors to delay full repayment on the note. As we noted on Sunday, Brilliance Auto Group Holdings, a Chinese automaker linked to BMW, also announced that it has defaulted on 6.5 billion yuan ($987 million) of debt.
Backed by the prestigious Tsinghua University, Unigroup said it will keep raising funds to repay investors the bond’s principal and interest. According to Bloomberg, the chipmaker’s bonds tumbled since late October, crashing from par to just 25 cents, after its decision not to buy back a privately issued 6.5%, 1 billion yuan perpetual bond triggered concerns about its repayment abilities. Worries about Unigroup’s finances and fate have persisted since two years ago, when Beijing ordered education providers to distance themselves from commercial operations.
Separately, and also on Monday, Brilliance Auto - which pre-announced its own bond default in late October - confirmed its inability to repay a 6.5 billion yuan ($987 million) bond via a statement posted on Chinabond.com, adding that it had 144 million yuan of interest overdue. It attributed its defaults to tight liquidity and a failure to obtain approval for credit line rollovers. The defaults have affected production and operations and worsened its financial situation "significantly", said the carmaker which is owned by the Liaoning provincial government and owns 25% of a venture with BMW.
Brilliance Auto’s bonds slumped after it failed to repay its 5.3%, three-year 1 billion yuan bond due Oct. 23, intensifying longstanding concern about its finances since its Hong Kong-listed unit agreed two years ago to give up control over its joint venture with BMW by 2022. The China-based joint venture has been a crucial source of earnings for the group.
According to a Brilliance statement, the company's soured debts included bank loans, bonds, financial leasing contracts and trust loans. The revelations of the automaker’s debt blowup came after a creditor filed an application to initiate a local court-led restructuring against the Liaoning-based parent of BMW’s joint venture partner in China.
As reported last night, and as Bloomberg notes today, amid the deepening distress officials from China’s State Council have asked government departments to conduct a risk assessment, whose aim is to ensure stability in financial markets and to prevent any spillover effects from the credit sphere that could cause systemic risks. If there is a risk of contagion, the regulator will have a response plan, although the initiative doesn’t mean that there will be bailouts, according to sources. Regulatory authorities have made inquiries with senior executives of companies including Tsinghua Unigroup about their recent situations, a Bloomberg source said.
Meanwhile, according to Fitch, the number of defaults by China’s state-run firms is expected to rise marginally next year as the central bank has shifted toward a more neutral policy stance amid an economic recovery.
The new defaults will only add to the turmoil gripping the Chinese local bond market, as traders who until recently had never expected that SOEs would default, and had used that as an anchor in their investment decisions find themselves facing a whole new world, one where failure leads to default instead of bailout.