Chinese default heightens creditor anger

Posted on July 27, 2016

©Bloomberg

A series of bond defaults in north-east China is exposing creditors’ frustration at the lack of a transparent process for resolving bad debt as cash-strapped local governments step back increasingly from taxpayer bailouts.

President Xi Jinping’s push for “supply-side reform” is centred on cutting excess capacity and paring back credit to so-called zombie companies, many of them state-owned. That is setting up conflicts between creditors and local governments that rely on state factories for employment and tax revenue.

    Dongbei Special Steel, majority-owned by Liaoning province, has defaulted seven times on bond principal and interest payments worth Rmb4.8bn ($715m). In March its chairman was found dead.  

    In a sign of creditors’ mounting frustration, Dongbei Special bondholders circulated a draft petition last week calling on the main bond market regulator to take the unprecedented step of suspending approvals for all Liaoning-based companies.

    Ivan Chung, head of Greater China credit research at Moody’s in Hong Kong, said: “As there is no standard resolution platform or avenues — for example, court procedures — for bondholders to recover their claims after default, the bondholders may turn aggressive when the issuer is not co-operative.”

    North-east China, which is deeply reliant on state-owned heavy industry, has been the hardest hit by the economic slowdown, and more defaults are expected. How the latest case is resolved could set a precedent for creditor rights in similar cases.

    Bonds issued by state-owned enterprises were long considered to carry an implicit guarantee. That perception is changing following a series of SOE defaults over the past year. Overall, 17 Chinese companies have defaulted on domestic bonds in 2016 compared with 18 in 2015, according to Wind Information.

    Formal bankruptcies have surged over the past year after years in which debt disputes were mostly resolved through backroom negotiation. But most of those cases involve small, privately owned companies. In cases involving large SOEs, local governments still influence courts away from accepting bankruptcy petitions. 

    Lou Jiwei, finance minister, said on Sunday that the government will not intervene in corporate defaults unless the case poses a systemic risk.

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    Mr Chung said commercial banks, the main investors in Chinese corporate bonds, are more willing to challenge local governments to protect their balance sheets. In the past, lenders were willing to swallow some credit losses to maintain good political relations viewed as crucial for their broader regional businesses. 

    The latest bondholder proposal has removed the call for cutting off bond finance to all of Liaoning, according to the official China Securities News, but tensions remain.

    Investors are angry that Dongbei Special last week proposed swapping 70 per cent of its outstanding debt for equity, violating a pledge made in May not to engage in such swaps. They were also frustrated that Dongbei Special’s chairman did not attend the first two bondholder meetings. The company declined to comment.

    Jeffrey Qi, portfolio manager at E-Fund Management in Hong Kong, who invests in Chinese domestic bonds, said: “Of course creditors would love to have a bailout, but that’s not really the main issue. The problem now is the government won’t offer a bailout, but they also won’t allow a legal process of bankruptcy and liquidation. If they used a standard legal process, creditors wouldn’t have anything to complain about.” 

    Additional reporting by Ma Nan

    @gabewildau

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