While the market is bracing for probably dismal data on China’s trade, which will once again stress the significance of external risks for the policy of global central banks, China’s corporate debt market turns our attention to its troubles. Since Beijing formally acknowledged the existence of the institution of bankruptcy last year, a snowball of corporate defaults has continuously grown and peaked in 2018. Then the amount of bad liabilities was 119.6 billion yuan.
Some data as a courtesy of Bloomberg:
2019 now promises to take the bar higher in terms of the number of bankruptcies. Two large Chinese companies could not find funds to service the debt by the beginning of February, topping the list of the largest companies in terms of assets declared bankrupt in China.
The first company was Minsheng Investment Group, a private investment fund with interests in real estate and renewable energy. The company was supposed to redeem the bond with a nominal size of 3 billion yuan on January 29, but after asking for a delay of three days, it still could not fulfill its obligations, Bloomberg reported.
Minsheng Investment Group is the largest investment conglomerate in China, which includes 59 private investors, and which received a license in 2014, the November bond prospectus says. According to the Chinese credit agency, the size of the company’s liabilities is 232 billion yuan, assets – 310 billion yuan as of June 30, 2018.
The second company, Wintime Energy, has kept investors in suspense since last year. It defaulted in 2018, but despite debt restructuring, the firm also failed to make payments to investors last week.
The default of such large borrowers indicates that the existence of a “lender of last resort” in the face of the Chinese authorities can no longer serve as a universal means of comfort for Chinese investors, so China’s measures to reduce the leverage in the economy will be exacerbated by tension in private financing of the corporate debt. And the recent return to stimulating measures will have a lesser effect, so the readiness of private investors to invest in risky assets has long been lost. The extreme non-selectivity of measures to provide liquidity on the part of the authorities also means the loss of the traditional benchmark / signal for the investor, since “it is not clear where to invest if everyone can fall”.
Accordingly, risk management at the level of investors, is aggregated in two market indicators, through which risk aversion is fundamentally expressed. This is the term spread in the yield and the credit spread Term spread is the difference in yields between long-term and short-term maturity papers, credit spread is the difference between yields of lower-quality and better-quality securities. Quality and term, two parameters.
It is reasonable to assume that in the event of an increase in risk, a rational reaction of the investor will be to limit the investment horizon and shift to better quality assets. Term and credit spread, respectively, will have to rise, which is happening now in the Chinese market:
The term structure of Chinese bond rates shows that the yield curve is now more “concave” than 6 months earlier. That is, the demand for short-term government bonds increased, but fell on long-term (term spread increased). This is the consequence of limiting the investment horizon. And what is the situation with the credit spread?
From the left graph it can be understood that the yield on quality papers increased sharply in 2018 (outflow from them), and from the right graph that the relationship with the yield of securities with economic parameters is quite simple – more orders the company receives (tracked through the standard production PMI) – the better is quality of its debt. China is all about one big factory, right?
For troubled corporate borrowers in China, the classic problem of asset-liability mismatch is quite typical. Return on investment, i.e. cash flows on assets are more “delayed” and “stretched” than the maturity dates of liabilities. Against the background of the outbreak of the authorities’ struggle with over-lending (i.e., tightening access to financing, in particular through shadow banking), companies cannot take a loan to service their debts as, the problem is aggravated by the “delay” of the investment cycle in the downturn phase (or earlier transition into it?). The return on investment falls, the liquidity of assets decreases, making it difficult to sell them to service the debt.
For example, Wintime Energy’s liabilities have quadrupled over the past 5 years! From such a growth rate of debt, it’s clear how strongly the activity of companies in China depends on access to cheap loans.
Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.