Six private companies in the province of Shandong have defaulted or come dangerously close in the last three months, sending chills down the spine of even seasoned investors.
The six companies owe 68.1 billion yuan ($9.7 billion) to debtors in total, but the figures could be just the tip of an iceberg. Due to a common practice among Shandong companies to guarantee each other's debts, investors fear that other companies in the same region or sector could be dragged down as these six firms face distress.
«Shandong’s privately-owned enterprise default rate isn’t particularly high compared to the national one but recently, the risks have exploded,» said Jenny Huang, Director of China Corporate Research at Fitch Ratings, who was quoted in «Bloomberg»(behind paywall).
Default Rates Jumped
Bond investors of Chinese companies face uncertain days ahead. Defaults onshore climbed from zero just a few years ago to 126.7 billion yuan ($18 billion) in 2019. In Shandong and elsewhere, policymakers have shown willingness to let some weak companies fail, even though they are also under pressure to keep the economy growing and the markets stable. Recently, the Chinese government has allowed one state-owned company to default, as reported by finews.asia.
The default rate for bonds issued by non-state companies across China increased to a record 4.5 percent in the first 10 months of 2019, Fitch Ratings said in a December report. However, the figure might understate the true level of defaults given that some borrowers settle with bondholders privately rather than through clearinghouses. For state-owned companies, the default rate was just 0.2 percent in part due to the financial support from the government and better access to funding from banks.
Fears of Contagion
As a temporary solution, Shandong’s city and local governments have stepped in. It is unclear if the provincial government will do the same, which means that the province risks entering a «vicious cycle that spreads solvency risks to the entire region, swamping the good credits along with the bad,» according to an October report from S&P Global Ratings.
In Shandong, fears of contagion played out in late October, when bad news about a corn and steel conglomerate in the province erupted. This dragged down the bonds of at least two seemingly unrelated provincial neighbors. Similarly, aluminum producer China Hongqiao Group and food distributor Shandong Sanxing Group - known to back other companies’ debt- saw their bond prices fall to record lows, as investors fear that one could affect the other.
This is despite Hongqiao Group's reassurance to creditors that they do not have a business relationship. The yield on one of its dollar bonds hit 14 percent last week, a new high.
More Transparency
Meanwhile, investors are probably looking to see whether local companies can successfully refinance, notes Ivan Chung, head of greater China credit research and analysis at Moody’s.
«In the long run, companies must become more transparent and improve corporate governance to restore the confidence of financial institutions,» Chung said.
