On its website Dongbei Special Steel Group says that its mission is to “Do our best for civilisation and world harmony”. That lofty goal looks like even more of a mission impossible, given the discord between its bondholders and its owner, the Liaoning branch of the State-Owned Assets Supervisory and Administration Commission (Sasac).
The two groups have been engaged in a standoff over the company’s seven defaults since late March, the first by a local government-owned entity. Bondholders are pushing for bankruptcy at the steelmaker, while the provincial government has been trying to persuade the creditors to accept a debt-for-equity swap.
The case has become a lightning rod for debt restructurings as policymakers try to move market participants away from longheld assumptions about government guarantees and state-directed bailouts.
Chaori Solar was the first company to default in the onshore market in March 2014 (although it was subsequently bailed out) and since then default levels have been growing. Bank of China research shows that 18 onshore bonds totalling Rmb16.8 billion ($2.5 billion) have gone into default so far this year compared to Rmb12 billion throughout the whole of 2015. The majority (73%) have been concentrated in four sectors suffering severe overcapacity: solar panels, steel, coal and cement.
The same research says some companies have been able to resolve the situation more quickly, while others such as Baoding Tianwei and Sinosteel have begun debt restructuring negotiations, which will set a template for the kind of haircuts (i.e. losses) that bond investors must learn to endure.
Dongbei’s case highlights the difficulties that all parties face when there are conflicting interests at play. National Business Daily estimates that Dongbei’s total debt amounted to Rmb55.6 billion at the end of the first quarter, with estimated net cash flow of just Rmb670 million over the next three years.
Rating agency Moody’s points out that local governments are supposed to budget for bailouts and get them approved by the local People’s Congress, which meets once a year. But Liaoning government’s ability to help is limited by its own indebtedness, a result of its location at the heart of China’s ailing rust belt.
Liaoning suffered the lowest growth rate across 31 provinces last year. Analysis by financial pundit Yu Fenghui shows that the province had a debt-to-GDP ratio of 158%, up from 88% in 2012.
According to China Business News, the local government latched on to the central government’s plan to allow debt-for-equity swaps, proposing that 70% of Dongbei’s debt be swapped for equity and the remaining 30% paid off with fresh loans from its lenders.
Bondholders claim that they were shut out of the meetings discussing the idea and that they don’t want the equity of an unlisted company, which will be hard to monetise.
“The plan is about protecting government interests as much as possible with no consideration at all given to the lawful interests of bond holders,” one irate investor told Caixin Weekly.
Wallstreet.cn says that Liaoning Sasac failed to send representatives to any of the three formal meetings convened by bondholders. At the last one on July 20, bondholders reportedly tabled a proposal made initially by China Development Bank (CDB) that regulators suspend all debt issuance by Liaoning government entities. (Subsequently CDB posted an announcement on its website denying it was behind such a proposal.)
Yu says that “investors are likely to vote with their feet” regardless, which could have a “domino effect” on financing for the province. He also flagged a widely publicised opinion piece in People’s Daily on May 9, which concluded that forced marriages never work and that entities which cannot be saved should be shut down.
It seems the State Council agrees. In mid-July the minutes of a State Council Information Office meeting were leaked, and they suggested that debt-for-equity swaps should be used sparingly and not to prolong the life of zombie companies.
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