Back in October when we first looked at ground zero of the commodity price collapse, we found something striking: as of the end of 2014, one half of China's commodity companies with corporate debt were totally insolvent - based on Macquarie data they were unable to cover even one interest payment (let along debt maturity) with existing cash creation.
And since in the intervening time period, both commodity prices have dropped far lower, while Chinese corporate debt has proceeded to soar exponentially, we said it was "safe to assume that up to two-third of Chinese commodity companies are now at imminent danger of default, as they can't even generate the cash to pay down the interest on their debt, let alone fund repayments."
We concluded that "we fully expect this to be the source of the next market freakout: when the punditry turns its attention away from macro China, which has more than enough problems to begin with, and starts to focus on the cash flow devastation in China at the micro, or corporate, level."
To be sure, the Chinese government has done everything in its power to delay this day of reckoning and mask just how extensive the devastation at the local level is, by focusing its entire recently concluded People's Congress on the topic of sustainability and debt leverage, going so far as to propose a wholesale, and utterly mind-boggling, debt-for-equity exchange at the bank level, one which would involve the nationalization of China's insolvent commodity enterprises. Alas, we along with most rational observers, are skeptical this plan would ever get off the ground, as it would mean encumbering banks not with secured if impaired loans, but with unsecured equity in still insolvent companies, in the process making China's solvency problems even worse.
That said, the punditry has indeed started to focus away from macro China and to the "devastation at the corporate level", most notably in a recent Reuters article which suggested that "China's campaign to slim down its bloated industries could be derailed by more than $1.5 trillion of debt in its steel, coal, cement and non-ferrous metal sectors, which threatens to overwhelm local banks."
The story is well known: China is providing more than 100 billion yuan ($15 billion) in the next two years to handle layoffs from coal and steel, but that will only be made available once debts have been settled. Critics say there is no clear mechanism for tackling the debt burden, which will put huge strain on the weakest sections of the banking sector.
The debt figures, revealed in papers submitted to China's parliament this month, highlight the dilemma facing state firms grappling with surplus capacity and how difficult it will be to pull off this central plank of Beijing's economic reform plans.
Costs for the estimated 1.3 million coal-sector layoffs alone are as much as 195 billion yuan, and coal industry delegates attending parliament urged government to provide more support to deal with the mounting debts of hundreds of stricken "zombie" firms.
* * *
A lawyer who handles steel industry non-performing loans for mid-sized Chinese banks said: "Banks' fear is not without reason. The steel sector's continued slump increases the difficulty of disposing of outstanding non-performing loans."
The four sectors targeted in the battle against overcapacity owe around 10.2 trillion yuan ($1.56 trillion), according to documents submitted to parliament by Wang Mingsheng, head of Anhui-based coal firm Huaibei Mining.
China's statistics bureau puts coal and steel debts alone at 8 trillion yuan, of which about a third is bank debt. If 20 percent of that were to go bad in 2016, which industry analysts say is not unrealistic, it would raise Chinese banks' non-performing loans by nearly half.
Therein, as the bard said, lies the rub, and explains why China will continue jawboning and talking instead of taking any decisive action as there is simply no effective way out: once the debt starts being marked to something resembling fair value, it will unleash a tsunami of insolvencies which Beijing will be helpless to stop, which would then lead to mass layoffs in the tens of millions, social unrest and possibly culminating with civil war as tens of millions of angry workers are no longer able to make enough money to feed their families.
* * *
And while Beijing dithers, and does its best to kick the can as far as it can without doing anything, it was too late for one person: on Friday morning, Dongbei Special Steel Group reported that the company's Chairman Yang Hua, 53, was found dead after hanging himself in his residence.
We tried to find if the company is at or near insolvency and were unable to confirm this suspicion until last night, when a Chinese news report confirmed that as we expected, the company is indeed insolvent and will most likely be unable to make a 800 million yuan bond payment. To wit:
Dongbei Special Steel announced on the evening of March 25 that, due to tight liquidity, deposit principal and interest payment uncertainty, 800 million yuan bonds maturing 27 15 Eastern Steel CP001 (called the Northeast special steel Group Co., Ltd. 2015 year the first phase of short-term bonds) or face default.
It is reported that the current short margin issue size of 800 million yuan, 6.5% interest rate, the total amount of principal and interest payable of 852 million yuan, the lead underwriter for the China Development Bank.
Joint credit 25 afternoon announcement in Chinese currency network, in view of the Northeast Special Steel, chairman of death by hanging and 15 Eastern Steel CP001 is about to expire payment of principal and interest, will be included in the Northeast Special Steel lowered the credit rating watch list.
At 13:20 on the 24th, the Dalian City Public Security Bureau received a report, found that the chairman Dongbei Special Steel Group Co., Ltd., party secretary Yang Hua (male, 53 years old) Death by hanging at his residence. At present, the authorities are conducting investigations.
But why is this a problem: historically the Chinese government, either directly or indirectly through state-owned banks has mostly bailed out insolvent companies, especially those in the commodity sector. Has something changed this time? It appears the answer is yes.
Earlier this week, Caixin reported that Guangxi Nonferrous Metals Group Co., a state-owned enterprise in the southern region of Guangxi, said in a statement given to the Shanghai Clearing House, on February 22 that it filed an application for bankruptcy in Nanning Intermediate People's Court in December. What makes this bankruptcy particularly notable is that Shanghai Clearing House is a state-backed financial institution for the interbank market. In other words, the government is now allowing even state-backed companies to go under, a radical departure from its recent bailout ways.
Guangxi Nonferrous owed 14.51 billion yuan to 108 creditors, namely subsidiaries, financial institutions, suppliers, construction companies and private bondholders. The largest creditors are a subsidiary named Guangxi China Tin Group Co. Ltd., which is owed 1.63 billion yuan, and China Development Bank, which holds a debt of 1.60 billion yuan.
The firm has received government subsidies but still reported a loss of 2.29 billion yuan from 2012 to 2014, its financial reports show. In June last year, Guangxi Nonferrous said it was having difficulty repaying its bonds, citing excess capacity and falling prices.
Guangxi Nonferrous was founded in 2008 in Nanning by the State-owned Assets Supervision and Administration Commission, a central government agency that oversees state-owned enterprises, with registered capital of 1.16 billion yuan. The Guangxi government wants to protect its nonferrous metals industry.
"The nonferrous industry is facing downward pressure and the company had limited return on new investments in the past few years," a person close to Guangxi Nonferrous said. "These factors have resulted in tight cash flow."
All of this was expected and is proceeding just as we warned last October: after all there is only so far you can stretch reality before the lack of cash flow catches up to you.
But what makes this default especially curious, in addition to the fact that the bankrupt company is an SOE, is that the lender in the case of Guangxi is the same as that behind the imminent, and now tragic bankruptcy, of Dongbei: China Development Bank.
The problem was solved when China Development Bank agreed to help, a bank employee told Caixin. But Guangxi Nonferrous defaulted on two other bond payments that were due in November and February, he said. The company is being restructured, several people with the knowledge of the matter said.
Guangxi Nonferrous' executives met with creditors on March 18 to discuss restructuring, but no detailed plans were drawn up, the sources said. The management team said at the meeting that the Guangxi government promised to see that the restructuring was done in six months.
And while we lament that there is no way to buy CDS on China Development Bank, these two defaults hint at big trouble ahead for insolvent corporate China.
For the past four years China had effectively bailed out and otherwise "saved" all of its insolvent companies, but that period of wholesale rescues now appears to be over: are these two defaults confirmation that the tipping point in how Beijing handles bankruptcies, has finally arrived.
If so, how many more suicides by hanging (or otherwise) are imminent for China's commodity, and financial, sectors. One thing we know is that courtesy of $36 trillion in Chinese bank "assets", amounting a whopping 367% of GDP...
.... the short answer is "a lot."