Beijing Put RIP?

A flurry of SOE defaults nettles bond investors

A general view of Shanghai's financial district of Pudong amid heavy smog in Shanghai

Murky times for Shanghai firm

Daoist philosophers believe when nothing is done nothing is left undone. And if governments follow this libertarian principle, social and economic harmony will naturally follow.

This small-government approach hasn’t won over many followers among Chinese economic planners. But following a spate of defaults among state-owned enterprises is the Chinese government now taking a Daoist ‘do nothing’ philosophy when it comes to bailing out local bond market investors?

The issue has come to a head following a default by Shanghai Yunfeng Group – named after Yunfeng Mountain, site of a famous Daoist temple. Caixin Weekly reported that the energy firm had defaulted on two bonds totalling Rmb2 billion ($308 million).

Yunfeng has now joined a growing SOE club that has either missed bond repayments or suspended their bonds from trading. The lengthening list comprises China Coal’s unit Shanxi Huayu Energy, Shandong Shanshui Cement, Sinosteel, China National Erzong, Guangxi Nonferrous Metals, Dongbei Special Steel and Baoding Tianwei. (The latter, a unit of state-owned weapon maker China South Industries Group, was the first to default on Rmb4.5 billion in debt in April 2015 and was placed into bankruptcy earlier this year, see WiC279).

In Yunfeng’s case, what appears to have caused fury among bond investors is their belief that Greenland Holdings, the third biggest real estate firm in China by assets, and until late last year the controlling shareholder of Yunfeng, should be repaying Yunfeng’s debts.

The Hong Kong and Shanghai-listed Greenland is 48% owned by the Shanghai municipal government. According to Caixin, bondholders are now threatening to sue not only Yunfeng and Greenland but also bond underwriter Shanghai Pudong Development Bank on the grounds of inadequate disclosure.

Creditors have also complained to the Shanghai Stock Exchange, which has since taken the unprecedented step of blocking Greenland from issuing Rmb10 billion in new bonds while the investigations are ongoing.

Greenland has publicly stated it is not responsible for repaying Yunfeng’s debt because it did not guarantee it and reduced its stake in the group to 20% (from more than 50%) last October. Caixin calls this a case of “debt dodging” and brokers tend to agree. A CICC research report suggests that Greenland is trying to “whitewash its responsibilities”.

Analysts say that in contrast to international norms most domestic bond deals carry very few covenants. In the international bond markets it is normal for creditors to be granted a put option if the borrower in question undergoes a change in control. Likewise if a cross-default clause had been put in place, Greenland would not have been able to dissolve its liability in Yunfeng via a last-minute shareholding change.

Nevertheless news website says Greenland may yet step in and resolve Yunfeng’s repayment problems to prevent its own reputation from being tarnished further. The website quotes a source close to the company who says that it will inject Rmb1.1 billion and take ownership of a group of Yunfeng subsidiaries.

Bigger picture: rating agency Moody’s thinks bond investors need to start sorting the wheat from the chaff since the central government will probably only bail out strategically important state firms in future.

“Debt restructuring will become the norm in resolving the debt burden of financially distressed SOEs in overcapacity sectors” it wrote last week.

“The market isn’t used to hearing about firms’ debt problems,” Caixin also concluded. “And because they trusted government bailouts [the so-called Beijing Put] many investors, until recently, accepted a lack of financial transparency among bond issuing companies.” It says Beijing is drafting guidelines to improve disclosure rules and credit ratings.

Meanwhile, in further bad news for bond investors in state firms, China Railway Materials also asked for a trading suspension covering Rmb16.8 billion of bonds pending a debt restructuring.

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