Metal fatigue

Defaulting in Dongbei

Being the first to default is a dubious bragging right. And in China’s local bond market it turns out to be a confusing one too as evidenced by the default of a steel producer from the northeastern city of Dalian.

Dongbei Special Steel Group said it was unable to repay an Rmb800 million bond that was issued a year ago. Although it claims to have turned a profit last year, its cashflow situation prompted the default. Other short-term notes amounting to Rmb6.4 billion ($988.9 million) are still outstanding, says 21CN Business Herald.

The first defaulter in China’s onshore bond market – solar energy firm Shanghai Chaori in 2014 – was a privately-owned firm. Last autumn there was the debut default by a state-owned enterprise (SOE), when Baoding Tianwei, a power equipment maker, failed to make a coupon payment. Tianwei’s troubles featured in news bulletins because it was a unit of China South Industries Group, one of a smaller group of “central SOEs” under the control of the asset administrator Sasac at a national level. As a smaller state enterprise, Dongbei Steel falls into a different category. Its largest shareholder is Liaoning’s provincial state asset agency, which owns about 70% of the firm, with the state asset manager from Heilongjiang, another northeastern province, holding another 15%.

That means that Dongbei Steel is the ‘first’ locally-administered SOE to default. The fact that the bond was arranged by China Development Bank, a major policy lender, sent a further chill through the market. It says that it tried to rally support from the municipal shareholders, but that none was forthcoming.

The failure also says something about China’s steel industry, which has seen its output more than double in the decade to 2015, and now produces almost half of the global total. That’s far too much for local needs, leading to accusations overseas that Chinese firms have been dumping their excess production. It’s too much steel for policymakers in Beijing as well, who have been talking about trimming down the industry for years. Part of the strategy is to deny bank loans to non-favoured producers, which has contributed to the pressure on bond repayments because many mills have turned to short-term commercial paper for working capital.

Investors have backed the bonds in the past because local government shareholders were seen as guarantors. But this perception is being called into question. “These depth charges in the local bond market are going to blow up more than Dongbei Steel,” a local analyst told Wallstreetcn.com. “With industrial overcapacity being reduced and ‘zombie’ enterprises getting cleaned up, the local governments are less willing to foot the bill. Declining tax revenues are making it harder to make repayments too, which means that the rigid honour system of the local SOEs is crumbling.”

In February, the central government announced that at least 500,000 steel workers were expected to lose their jobs as part of new efforts to cut capacity by up to 150 million tonnes over the next five years, equivalent to about a fifth of current output (annual capacity is closer to a billion tonnes).

When the prospects looked bleak in the past, steel producers bunkered down and waited for better days, says Cai Rang, chairman of the China Iron and Steel Research Institute. “Everyone would think: ‘winter has come, so spring cannot be far off,” he told China Economic Times.

This time it might be different, Cai says: “Now the macro environment has changed, and most people believe that the steel industry won’t have another springtime. In short, steel has already entered the post-industrial era, and the effects of restructuring, mergers, acquisitions and capacity reduction going on now may be different to before.”

These brutal realities could force the sector’s local government backers to take a different view on bond bailouts. And as Dongbei Steel floundered last week, there was news from Tianjin that the municipal authorities have set up a creditor group to help Bohai Steel Group, another locally backed SOE, to negotiate a restructuring of Rmb192 billion in debts. Last Sunday it was announced that creditors had agreed to extend the maturity of their loans and lower the interest rates under a second restructuring plan for the steelmaker, according to Caixin magazine.

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