China Faces First Corporate Bond Default
China is set for the first-ever default in its fast-growing corporate bond market, whose total value is now estimated by Standard & Poor’s (S&P) at around US$12 trillion.
Shanghai Chaori Solar Energy Science & Technology, a manufacturer of solar cells, has admitted that it will be unable to pay the renminbi (RMB) 89.8m (US$14.6m) annual interest on a RMB1bn bond that it issued two years ago and has a March 2017 maturity.
Chaori has until the bond’s anniversary, on 7 March, to pay the interest to investors but said in a statement: “Due to various uncontrollable factors, until now the company has only raised RMB4m.”
To date, the Chinese government and state-owned banks have avoided defaults among risky borrowers by providing bailouts or debt extensions, keeping borrowing costs low for companies with high debt. Local governments intervened periodically to prevent defaults in the onshore corporate credit market in order to maintain economic and social stability.
In particular, corporate bond defaults have been prevented because China has a keen interest in expanding its onshore bond market. Investors responded by flocking to Chinese corporate bonds on the belief they have an implicit guarantee, helping to fuel growth.
Chaori avoided a default a year ago after a local government in Shanghai persuaded its bank to defer claims on overdue bank loans, according to the company’s filings. However, a further government intervention is seen as unlikely, although the company said it would try to minimise investors’ losses.
As of the end of June, the last period such data are available, Chaori had failed to pay 12 banks almost RMB1.5bn of loans on time.
An earlier potential default occurred in 2012, when chemical fibres producer Shandong Helon was unable to meet RMB400m of maturing commercial paper, but was averted by local government intervention.
Even a relatively minor default such as Chaori could raise the risk profile associated with corporate bonds, raising yields and slowing issuance at a time when fixed asset investment growth in the economy is already slowing. It would also mark the first default by a publicly traded bond since the Chinese central bank began regulating the market towards the end of the Nineties.
Given the size of the Chinese corporate debt market, the knock-on effect from a default could be material. According to a Thomson Reuters analysis of 945 listed non-financial companies total debt rose from RMB1.82 trillion to RMB4.74 trillion between 2008 and 2013.
Fitch Ratings suggested that a default by Chaori could prove positive for the market in the long term as it will instil greater discipline to price credit risk more effectively.
The credit rating agency (CRA) noted that Chaori’s expected default coincides with the annual National People’s Congress (NPC), a meeting of China’s political leadership. The fact that the Chaori default has been allowed to emerge could signal a shift in the government’s stance towards a greater tolerance of outright corporate defaults. Chaori’s bonds have a large retail investor base, which makes the case even more noteworthy.
The onset of an outright default is likely to lead to a re-pricing of corporate credit risk, as the common perception that the government will bail out all struggling companies falls away. Weaker Chinese corporates may therefore see an increase in their onshore borrowing costs. Fitch expects a reduction of onshore lenders’ and investors’ risk appetites, which could pressure frailer companies’ liquidity, especially in sectors challenged by cyclical downturns and persistent capacity surpluses.
The CRA sees onshore corporate credit defaults as a long-term positive for China’s financial system as it should instil greater market discipline and lead to a more efficient allocation of capital among corporate borrowers. It may also prompt further regulatory progress to provide more clarity on the legal process governing domestic bankruptcies and restructuring, which should benefit both onshore and offshore creditors in the long run.
Fitch expects Chaori’s default to have relatively limited impact on Chinese corporate issuers of offshore debt, although the credit risk premium could widen modestly in the short term. Compared with the onshore market, the offshore market has a higher degree of sector and individual company differentiation in pricing.