When Hank Paulson says that China is likely to face a debt-fuelled crisis, the world – or, at the very least, the world’s bond investors – should probably take note. As treasury secretary, the former boss of Goldman Sachs steered the United States through the global financial crisis in 2008. He’s also visited China more than 100 times, and was the driving force behind the ‘Strategic Economic Dialogue’ platform that was designed to facilitate better understanding between Washington and Beijing.
Last month, Paulson published a new book, Dealing with China: an Insider Unmasks the New Economic Superpower. And many of his arguments do not make pleasant reading for the Chinese government as it tries to tackle the twin demons of slowing growth and rising leverage.
“It’s not a question of if but when China’s financial system faces a reckoning and will have to contend with a wave of credit losses and debt restructuring,” Paulson concludes.
Cracks were again evident earlier this week when China News reported that local government debt now tops Rmb16 trillion ($2.6 trillion), up 47% since the government’s last review in June 2013.
This means that combined government and corporate debt is already likely to have breached the $28 trillion recently estimated by McKinsey (or 282% of the country’s $10 trillion GDP last year).
This may explain why the central government has once again rushed to the aid of a distressed borrower despite its protestations that it will allow selective defaults as long as they do not induce systemic risk.
Last week, solar panel manufacturer Baoding Tianwei was the first state-owned borrower to default in the domestic bond market, after failing to pay Rmb85.5 million in interest on a Rmb1.5 billion bond.
But just four days later, Caixin Weekly was reporting that the bond’s underwriter, China Construction Bank (CCB), had been “persuaded” to offer a loan to the company (a unit of military contractor China South Industries Group) after the central bank stepped in to coordinate rescue efforts.
The news has not been well received in the domestic press, where analysts had been expecting that Baoding Tianwei’s case would be served up as an example to the rest of the state-owned sector. As Qian Qimin of Shenwan Hongyuan Securities told the Global Times: “It is of great importance to break the rigid repayment in China’s bond market so investors take bond issuers’ actual management and debt repayment abilities into consideration.”
Caixin Weekly speculates that this may not be the end of the matter as the bond’s covenants might enable investors to accelerate repayments. If they do, the magazine says, it is hard to know how CCB will react.
But China Times also says that CCB’s initial decision to let the bond default is very telling. It calls this change of attitude “extremely significant” for the future of SOE lending in the country.
Meanwhile, in the offshore bond markets, spreads barely moved after property developer Kaisa Group confirmed that it has defaulted after failing to pay $51.6 million in coupon payments on two dollar-denominated bonds. Investor reaction may have more to do with the fact that large swathes of the property sector’s outstanding dollar-denominated bonds have been trading at highly distressed levels since the end of last year.
By WiC’s count, a total of 15 property companies with $8.89 billion of notional principal are trading more than 1,000 basis points over US Treasuries (representing almost 18% of the sector’s outstandings).
Renhe Commercial and Glorious Property Holdings hold the unhappy distinction of trading at the widest spreads. Both have bonds maturing this year, but find themselves trapped between market unwillingness to offer further refinancing and the balance sheet conundrum of how to repay their existing bonds from their negative free cashflows.
Renhe has a $300 million 11.75% bond due on May 18. The deal is currently trading on a yield of 30.4%. Glorious Property has a $300 million 13% bond due in October. This bond is yielding an even more eye-popping 65.49% (its credit ratings are CCC-/Ca which indicates a high probability of default).
Signs of stress have also been apparent outside of the property sector. As we reported in WiC277, coking coal importer Winsway Enterprises has already entered restructuring negotiations after missing a coupon payment on its $309.3 million 2016 bond. Investors are also pricing in a default for coal miner Hidli Industry, which failed to refinance a May 2015 bond through a tender offering last autumn. The bond is currently trading on a yield of 67.69%.
But the wider market has stayed remarkably sanguine, bolstered by media reports that the central bank is considering making direct purchases of local government debt. That seems to suggest that the central government’s interventionist instincts are alive and kicking, whatever is said to the contrary.
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