Fears that more Chinese corporate borrowers are likely to default in the coming months and years have cranked up a notch after China Energy Reserve and Chemical (CERC) failed to repay its dollar bond, spreading some of the disquiet that has been rumbling onshore in China onto offshore markets.
The $350 million default, confirmed at the weekend, underscores Beijing’s determination to lance the boil of excessive debt within the country's financial system and shows the government should not be relied upon to bail out even those firms with deep ties to the state, investors told FinanceAsia.
CERC is controlled by the Beijing government and by cash-rich PetroChina, China’s largest oil and gas producer and the listed arm of state-owned China National Petroleum Corporation. It is engaged in oil and gas trading, logistics and distribution, according to its website, and counts other state-owned oil companies such as Sinopec and CNOCC, as well as PetroChina, among its key clients.
“The risk of default among Chinese borrowers is underappreciated,” a Hong Kong-based fund manager told FinanceAsia, declining to go on the record due to the sensitivity of the subject. “It is clear to me that the Chinese government is getting serious about systemic risk in the banking system, and the deleveraging campaign will eventually force more companies out of business.”
Defaults in China have partly contributed to the relatively tepid tone of China's offshore bond market, with new issuance levels down on last year. Based on data collated by Dealogic, Chinese borrowers have only sold $30 billion of international bonds so far this year, compared with $37 billion for the same period a year ago.
They have also contributed to a widening in spreads between US government bonds and high-yield notes and are driving investors to conduct more strenuous levels of due diligence.
"Relative to the recent benign default history pertaining to Asian and Chinese credits, we expect the pace of defaults to rise going forward, which warrants rigorous fundamental analysis and careful security selection process," Karan Talwar, an emerging markets investment specialist at BNP Paribas Asset Management, told FinanceAsia.
"In the past few years, Chinese and Asian investors have been major buyers of Chinese US dollar-denominated debt, as they think they have better access to the issuer and understanding of the industry, but I think it is no longer sufficient to just rely on implicit government support -- credit fundamentals will matter much more going forward," he said. "As China’s deleveraging campaign gathers force, you should expect to see higher default rates in both the onshore and offshore market."
CERC said it planned to offload certain assets to ease the cash crunch, without providing further details on how much it plans to raise.
As a result of the missed payment, the company automatically defaulted on its 2021 and 2022 bonds too. It will stop paying interest on the two bonds and begin restructuring talks with bondholders.
“We’ve seen some private banking investors and fund managers punting the [2021] bonds at 30 cents,” a bond trader told FinanceAsia late Tuesday, after seeing the bonds fall by 45 points in two days.
That left them below another distressed name currently in the market -- Hong Kong house builder Hsin Chong, the trader said.
Hsin Chong said it had failed to redeem its $300 million 8.75% senior bond maturing on May 18. The missed payment also triggered a default of its $150 million 8.5% bond due in 2019.
Hsin Chong said it was in discussions with two other property companies, Poly Property and Kaisa, about a potential lifeline.
“We expect to see more credit spread differentials both for investment-grade but more so for high-yield credits, and the pace of spread increase for high-yield bonds should be faster than investment-grade due to higher default and liquidity risk,” Talwar said.
