A C¥1 billion bond default by a state-owned enterprise in China could usher in a string of such defaults, sending tremors through the world's second-largest market for debt. The Chinese government appears to have abruptly pulled its support for the company's credit, something it had reaffirmed only the previous month.
The company in question, the mining operator Yongcheng Coal and Electricity Holding Group, failed to pay both the principal and interest on a C¥1 billion (US$141 million) bond when it came due on November 10. It is a subsidiary of Henan Energy and Chemical Industry Group, one of the largest state-owned enterprises in Henan Province. So its sudden collapse on payments led to a selloff of corporate debt across the province.
The default raises the risk of cross-default with its parent, according to Standard & Poor's. That puts C¥50 billion (US$7.1 billion) in debt at risk. It also could signal the start of a string of defaults, S&P says, with provincial and the national government apparently willing to let state-owned enterprises go under.
The Yongcheng Coal default is strange in its timing since the company was allowed to issue a C¥1 billion medium-term note in October. That was assumed to be a sign that the government was backing the company, which has also been seeking to shed loss-making chemicals businesses and concentrate on profitable coal businesses, a process the government has also been encouraging.
"More defaults are coming as Chinese authorities refocus on deleveraging of SOEs now that the worst of the pandemic has passed," Chang Li, China country specialist at S&P Global Ratings, says. Li says default rates are still low enough that they are currently "unlikely lead to systemic risk."
China bears would say otherwise. Credit and banking specialists have long said there's a debt bubble waiting to burst in China. The government's system of state-owned enterprises and command-style economy used to mean that state companies were bulletproof. But critics question whether the national and especially the provincial governments have the willingness or the financial wherewithal to bail out all the troubled entities.
The Yongcheng Coal default caused a selloff in the domestic bond market in China. It also forced the scrapping of C¥20 billion (US$2.8 billion) in planned bond issuance in the subsequent week.
It's possible that even a large state-owned enterprise may be allowed to go under, as Beijing attempts to force reform on the state-owned sector. Li at S&P says that "risk aversion may have been heightened by a seemingly abrupt removal of government support."
Chinese officials may be encouraged to allow troubled corporate children to collapse as the economy rebounds. Then again, they also may not have the funds to help them anymore.
"YMD's missed payment surprised the market because it indicated the local government's attitude to provide support had reversed within just one month," Li at S&P says. "The market may see this as a signal that the SOE deleveraging and reform will accelerate as the economy recovers from the pandemic."
If the credit contagion spreads to parent company Henan Energy, it would impact a company that employs 164,236 people, with revenues of US$26.2 billion, according to figures from Fortune, which ranks it 486 in its list of the 500-largest energy and chemical companies in the world. Henan Energy cancelled a meeting with creditors due to occur last Friday because it grew chaotic, with too many creditors attending. Chinese banking stocks have also sold off over concerns the sector faces a wave of bad debts.
Yongcheng Coal said in a Tuesday filing that it does not have sufficient working capital to make payments on its commercial paper that comes due on November 22, leading to "uncertainty in making payments." For parent Henan Energy, around 45% of its onshore bonds would face cross-default risk, according to S&P.
China's state-owned enterprises are a key source of employment, and the driving force behind its heavy industry and infrastructure, not to mention "sensitive" sectors such as telecommunications. But Beijing is intent on reforming the bloated SOE sector, which carries an enormous debt load and includes many inefficient companies that would fail to compete, and could collapse, without government support.
Another state-owned company, Huachen Automotive Group, on October 23 defaulted on a C¥1 billion bond. Huachen Automotive, also known as Brilliance Auto and owned by the government of Liaoning Province, is the parent of a company that has a joint venture partnership with German carmaker BMW (BMWYY) in China.
Chipmaker Tsinghua Unigroup, which is owned by the prestigious Tsinghua University in Beijing and therefore the central government, defaulted on November 16 on a C¥1.3 billion bond, after failing to secure an extension for repayment. The chipmaker is a central component of Beijing's plan to develop a domestic semiconductor industry, but still failed to elicit the anticipated state support.
Chinese corporate debt amounts to three times the size of China's GDP. There have been 110 corporate bond defaults in China in 2020, amounting to C¥126.3 billion (US$17.8 billion), according to Chinese financial-data provider Wind. That puts them on track to exceed the 184 defaults last year, which totaled 149.4 billion (US$21.1 billion). Private bond markets are increasingly popular for state-owned companies. Fitch estimates that there is almost C¥700 billion in bonds from state-owned enterprises set to mature this year, compared with almost C¥500 billion from entirely private companies.
The administration of President Trump last week issued an executive order that bars U.S. investors from taking stakes in the securities, including equities and bonds, of 31 companies that the Pentagon says have ties to the Chinese military. As I explained, that puts at least US$500 billion in market capitalization of U.S.-listed Chinese stock at risk, including the enormous Chinese phone companies China Mobile (CHL) and China Telecom (CHA) , which are listed on the New York Stock Exchange.
