Skittish investors highlight China credit fears

Early redemption requests on domestic private placement notes add to nerves following a feared – but avoided – trust default in January.

A move by a group of investors in China to seek early redemption of private placement notes highlights the skittishness that exists in the market amid concerns of possible defaults within the system.

The three-year 6% private placement notes (PPN) issued by Luoyang Mining Group have attracted market attention as two investors asked for early redemption, rarely-seen in China in recent years.

Guangzhou Rural Commercial Bank and Bank of China Investment Management, who respectively bought Rmb100 million and Rmb50 million of the Rmb500 million PPNs, on Tuesday held a creditor meeting and voted with other investors to agree on a proposal to ask the company to redeem the notes unconditionally and pay the interest based on the 6% coupon.

The reason: a perceived change of ownership.

A statement released by Luoyang Mining Group revealed that it had lost control of China Molybdenum, a Shanghai- and Hong Kong-listed subsidiary and the second-biggest producer of the steelmaking material in China.

China Molybdenum’s former second-largest shareholder, Cathay Fortune, now holds 1.8 billion shares, or 36%, of the company, overtaking the 35% stake held by Luoyang Mining Group.

The change in China Molybdenum’s controlling shareholder structure will make a big difference in the group company’s balance sheet. According to a rating report by China Credit Rating, CM contributed  96.23% of LMG’s revenue in the financial year 2012 based on the consolidated accounts. “The Group basically does not own any operational business after it lost the control in China Molybdenum,” said CCR in the report.

However, the early redemption request by the investors is surprising because the debt is not large and there is no obvious sign that the Luoyang Mining Group could not pay back in time — the first payment date is August 12.

“That some companies lost control in their substantial subsidiaries is not an infectious event and at this moment it’s hard to say this single one means overall credit risk is rising,” said Zhang Yingjie, vice-general manager of research with domestic rating company China Chengxin Credit Management.

So, are the investors getting too nervous?

CCR put the group company in a negative observation list after the controlling shareholder change. The Group still holds debts of totaling Rmb1 billion medium-term notes due in May and October next year.  

“The parent issued debts backed by assets of their high-quality subsidiaries; similar cases surely exist in Chinese companies. The factor of consolidating financials of parents and subsidiaries should be included in the risk consideration,” said a source familiar with the PPN transaction.

The two investors are under more capital pressure than other types of investors due to their status as a bank and an asset management company, according to the source.

China’s central bank has required domestic banks to streamline their balance sheets and clear up borrowings deemed to be risky. Such mid-sized financial institutions are in greater need of maintaining adequate capital levels and have less ability to afford the loss if Luoyang Mining Group can’t pay their money back, said the source.

More broadly, China’s credit risks are accumulating. The country’s economy is transforming and slowing down, and many companies are experiencing difficult times as some industries have lost impetus, such as iron and steel or mining companies. There is a liquidity squeeze in the market that any further sign of tightening credit will lead to debt holders’ worries over their lending.

Analysts expect that this year will see a peak of credit maturity. According to Yang&Lee Trust, a Jiangxi-based trust firm, there are at least Rmb546 billion worth of trust products due to mature in 2014. Zhang Zhiwei, Nomura’s chief China economist, estimates the dollar amount of maturity of Chinese trust products will likely rise quarter-to-quarter from the first two quarters and peak in the third quarter.

Market watchers also believe that Beijing will allow a credit default in this year to help correct market risk perceptions and increase risk awareness, although in January a $3 billion trust product by China Credit Trust was finally bailed out by some strategic investors.

Analysts believe that a default may most probably happen to a non-bank issuer with a relatively small debt size rather than a large trust or banking product. 

“In this way, the government can ring the alarm of credit risks to the market, but also avoid systematic turmoil in the financial system,” said the source.

Investors know how to use their rights efficiently. According to the rules of the PPN, the issuer must garner 75% of bondholder support to leave the bonds’ terms unchanged. But the two investors hold 30% of the PPNs, which suggests the issuer is most likely to pay the bill early.

“The result will be released in three days after the meeting,” said Gao Qinghui, partner and director of the financial derivative and innovation legal affairs department with Beijing-based Yingke law firm.

It may be good that Chinese investors are getting more risk-sensitive and even over-reacting to the credit risks, a basic scenario needed for a market with increasing credit risks.

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