Trade war creates credit stress for Chinese manufacturers

Defaults start to pick up as smaller entities struggle for orders and financing.
The world’s factory is in trouble. While China held onto its title as the world’s largest manufacturer in 2018, the Sino-US trade war took its toll on its companies’ balance sheets, leading to a marked pick-up in defaults so far this year. 
This trade-induced credit stress has been further compounded by the fact that so many Chinese manufacturers are small and medium private sector entities, which struggle to obtain financing from a banking sector that prioritizes companies with explicit or implicit government guarantees.
Christopher So, a partner of PwC’s Hong Kong restructuring and insolvency practice, told FinanceAsia that even if smaller private sector entities do manage to source funding, “it’s usually in the form of short-term trade financing.” He added that, “any drop in orders may precipitate loan repayment pressure.”
Practitioners on the ground back this up. “Many manufacturers in southern China find it hard to get export orders,” said Willy Lin Sun-mo, chairman of the Hong Kong Shippers’ Council.
Douglas Sheridan, a Canadian businessman who works with footwear and apparel manufacturers agrees. 
He told FinanceAsia: “There’s significant pressure on Chinese factories, which suffered US tariffs. If they suffer more from a new US tariff round, then various entities in the footwear and apparel sectors will surely go under.”
And Wind data shows that they already are. 
Over the past year, manufacturing companies suffered a total of 121 rating warnings under the financial data provider’s methodology. This comprised 39 rating downgrades, 33 negative ratings outlooks, eight rating outlook downgrades and 41 ratings under observation. 
Financial institutions, including banks and insurers, came second with 71 rating warnings. Construction was a distant third with 31 rating warnings. 
Perhaps more worryingly, manufacturing companies accounted for eight of the 14 Chinese corporate bonds, which have defaulted on Rmb10.1 billion ($1.5 billion) by the principal amount so far this year according to Wind. 
This is a big jump compared to 2018 when manufacturers accounted for 24 out of the record 124 bonds that went into default, totalling Rmb120.56 billion ($17.87 billion).
One recent example is Kangde Xin Composite Material Group, which failed to re-pay an Rmb1 billion ($150 million) bond on January 15 and an Rmb500 million ($74.3 million) bond on January 21.
On January 23, the high tech materials producer also announced that the China Securities Regulatory Commission (CSRC) was investigating it for suspected violations of disclosure rules. Then on January 28, Kangde Xin it announced that it had received 23 civil lawsuits from a group of banks including ICBC and Agricultural Bank of China.
The Hong Kong Shippers’ Council Lin notes that financial pressures are piling up because orders are trying up after many US buyers rushed forward their orders for fear of future tariffs. 
However, not everyone is suffering equally. Chinese-based furniture and lighting manufacturers are less badly hit by US trade measures, argues Nadav Hassan, chief executive of Ven Global, a supplier of furniture and equipment for hotels in the US and Europe. Ven Global sources 90% of its products from China.
Hassan says that virtually all of the 100 furniture and lighting manufacturers he deals with produce for non-US markets. “I don’t think Sino-US tensions is going to cause many bankruptcies in this sector,” he commented. 
The Trump administration slapped 10% tariffs covering $200 billion of Chinese goods in September 2018. The US and China are currently in talks to try and reach a deal by March 1 ahead of another rise to 25%. 
But even if the trade war is resolved, Chinese small firms will continue to suffer due to the cost of plant relocation and disruption in supply chains, according to Andrew Collier, managing director of Orient Capital Research, a Hong Kong financial research firm.
“This will come on top of recent bad news, such as the first decline in Chinese industrial profits in three years, that is the result of a slowing economy,” he said. 
Chinese exports fell 4.4% last December, the worst drop in two years, according to official Chinese data. In December, the Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI) fell to 49.7 from 50.2 the previous month, its first contraction since May 2017. A PMI below 50 indicates a contraction in factory activity.
Jan Amrit Poser, chief strategist and head of sustainability at Swiss private bank, J. Safra Sarasin, believes that not all of Chinese manufacturers’ financial woes can be attributed to the trade war. He argues that Beijing’s earlier monetary restrictions have been a major factor too.
Money supply has been improving in recent months with the Chinese government pumping liquidity into the system. On January 16, for example, the China Banking and Insurance Regulatory Commission said that it would continue providing strong financial support to privately owned enterprises (POEs) in 2019 by increasing credit supply.
However as Moody’s wrote on January 24, “these policies will not significantly affect overall financing situation of POEs. The policy impact also varies with fundamentally sound entities benefiting most, with limited support allocated to weaker POEs.”
Moody’s said this is because financial institutions and bond investors have adopted a more cautious approach thanks to the rising number of POE bond defaults. 
“Some default cases exposed severe governance and disclosure problems in the defaulted POEs, further compounding investors’ risk aversion towards POEs,” the rating agency said. “We do not expect this situation to fundamentally change by the supporting policies.”
PwC’s So highlights that while only a minority of Chinese manufacturers have issued onshore and offshore debt, there is a risk of cross-default among the ones that have. 
In 2018, Chinese manufacturers issued 274 onshore bonds totalling $47.54 billion and 24 offshore bonds totalling $19.49 billion, according to Dealogic. The data provider shows that they accounted for 10.9% of total onshore corporate volumes and 16.4% of offshore.
In November, Nomura wrote that “we believe investors should be cautious about possible spill-over from the onshore to offshore markets if financial risk rises.”
In the year to January 28, domestic issuers executed four onshore bonds totalling $691 million, but none offshore according to Dealogic.
“The economic chill in China is spreading, threatening to weaken profitability across nearly all sectors in corporate China,” said a Standard and Poor’s on January 21. 
“We expect corporate default rates to rise modestly in 2019 due to rising maturities and declining debt serviceability,” it added. “We expect credit spreads for strong corporates to narrow, but weak companies continue to face a higher risk of downgrades and defaults. 
The agency concludes that poor sentiment, combined with trade tensions, could spiral into a broad-based decline.
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