Could China’s defaults accelerate?

Asset Class in Focus

Trade tensions, slowing GDP and the declining RMB create favourable conditions for Chinese bond defaults.

The mainland’s default rate is well past last year’s number and in Q3 Moody’s downgraded more Chinese companies due largely to liquidity issues and default risk.

Zhuzhou City Construction (Ba1 stable), a Chinese local government financing vehicle (LGFV), was downgraded to Ba1 from Baa3 “as a result of our reassessment of government support to LGFVs”, the ratings firm said.

Wuzhou International (Ca negative) was taken down to Ca from Caa1, “reflecting our expectations that the company will default on its repayment on senior unsecured notes”.

Additionally, Chinese coal miner Wintime Energy fell behind on its debt repayments earlier this year and is scrambling to avoid default, according to a Bloomberg report. “The company announced plans to include loans issued by its healthier subsidiary Huachen Energy as part of revised debt package.”

Moody’s reported it downgraded Huachen Energy (Ca negative) to Caa1 from B1.

To end of September, 24 Chinese companies, “mostly private, have defaulted on 48 bonds worth 56.7bn ($8.25 billion) this year”, according to Reuters, citing its own data.

By comparison, China had 17 defaults in the full year of 2017, according to mainland research firm Wind.

The defaults are still a small proportion of China’s $12trn bond market, and there are significant differences between US dollar and RMB, private and state and national and local government issuance.

However, investor sentiment toward Chinese bonds overall could turn worse due to macro-economic factors, the ratings agency warned.

Trade tensions with the US, slowing GDP growth and the declining value of the RMB vs the US dollar (down about 6% this year) create conditions for more defaults.

Aside from US tariffs that can impact sales to that market, an economic slowdown could reduce demand and a strengthening dollar vs the RMB could make raw material imports more expensive for domestic companies.

Moody’s took down China’s growth forecast for next year.

“We expect China’s growth to be 6.6% at the end of 2018, and slow down to 6.0% in 2019, reflecting the impact of deleveraging measures by the Chinese government to curb loan growth and de-risk the financial system as well as escalating trade tensions with the US.

“The slower, albeit still solid, economic growth will limit corporates’ earnings growth and will impact sectors in different ways.”

The ratings agency expects challenging funding conditions and rising financing costs, particularly impacting high-yield issuance.

 

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