HONG KONG / SHANGHAI (Reuters) — Credit
warning signs are flashing for heavily indebted Chinese
semiconductor, software and commodities firms as the government
cautiously steps aside to let market forces play a bigger role in
deciding winners and losers.
China's first-ever domestic bond default this month — a missed
interest payment from Shanghai Chaori Solar Energy Science and
Technology Co <002506.SZ> — shattered the belief that Beijing would
always bail out struggling companies.
"The Chaori default goes to show the government will begin to let
the market decide the fate of weak borrowers," said Standard &
Poor's analyst Christopher Lee in Hong Kong.
Lee said defaults would be "incremental but controlled" with sectors
including shipbuilding, metals and mining, and materials among those
showing the highest risk as China's economic growth slows and banks
tighten lending.
Chinese companies owe just over $1 trillion in domestic bonds, of
which 15.8 percent is coming due this year, Thomson Reuters data
showed.
While companies contacted by Reuters were confident they could
obtain credit, Chinese rating agencies have stepped up the pace of
downgrades. There were 77 companies downgraded in 2013, more than
triple the previous year's tally, according to ratings agency China
Chengxin.
A Reuters analysis of more than 2,600 Chinese companies found credit
metrics worsening across a range of industries. The software sector
was shouldering the heaviest credit burden with an average of 3.4
times more debt than equity. Semiconductors — a category which
includes solar companies such as Chaori — had a debt-to-equity ratio
of 2.6.
Across all listed Chinese companies, the average debt-to-equity
ratio was 0.85 in 2013, according to Standard Chartered.
It is unclear where China's government will draw the line on letting
market forces prevail. Premier Li Keqiang said in a news conference
on March 13 that Beijing was "reluctant to see defaults of financial
products but some cases are hard to avoid.
But social stability has traditionally trumped market reforms. If a
major employer or a high-profile company were to slip into distress,
the government is all but certain to intervene. The municipal
government of Wuxi, for example, threw a $150 million lifeline to
struggling solar company Suntech Power Holdings Co Ltd in October.
Local governments will be keen to protect companies that are
important tax payers and employers, but would be willing to let
smaller ones like Chaori fail, according to a Hong Kong-based
analyst with a U.S. bank, who declined to be identified.
18 YEARS TO REPAY
Materials companies look vulnerable as weak commodity prices hurt
profitability, leaving less money to repay debt. Although the metals
and mining sector's average debt-to-equity ratio is a manageable
1.4, bond holders see rising risk and have demanded higher yields
for holding the debt.
Xinyu Iron and Steel Co Ltd <600782.SS> for example, would need
almost 18 years to repay its total debt at the present rate of cash
generation. Its bonds due 2016 saw yields rise 160 basis points this
month alone to around 10 percent.
Xinyu did not immediately respond to emails and a phone call seeking
comment.
As a state-owned company, Xinyu would likely get government help if
it struggled to repay. Indeed, if Beijing failed to step in when any
state company faltered, that would set off louder alarm bells among
creditors.
Privately owned Nanjing Iron & Steel Co Ltd <600282.SS>, which has 4
billion yuan in bonds coming due in 2018, said it had many funding
channels available, including U.S. dollar debt, stock holdings and
bank loans.
"The bond is due in 2018. Our company has not made any repayment
plan since the time has not arrived yet," said Xi Siwei, an official
in the securities department at Nanjing.
Packaging materials company Zhuhai Zhongfu Enterprise Co Ltd
<000659.SZ>, which has 590 million yuan in bonds due 2015 and an
equal amount coming up for repayment in 2017, said the coming months
were a boom season for its business and cash flow would pick up,
easing debt servicing strains. If necessary, it could also sell some
assets.
"The industrial land held by us is worth more than a billion yuan
($161 million)," said board secretary Lishang Chen. "So selling one
or two plots of this land is sufficient to pay our debt."
Shandong Molong Petroleum Machinery Co Ltd <002490.SZ>, which owes
500 million yuan bonds due in 2016, said rising bond market yields
were of little concern because it had no plans to issue new debt and
bank interest rates were not as high.
"The yield has nothing to do with our ability to repay the debts,"
said board secretary Zhao Hongfeng. "We have no problem in repaying
the short-term debts."
WHAT IS NEXT
Beijing will continue to support companies that fit its policy
goals, which suggests large state-owned enterprises would be rescued
if they got into debt trouble, according to Steve Wang, head of
China research at Hong Kong-based boutique investment bank REORIENT
Group.
"We will not see a big-bang collapse but rather small fire crackers
in a 'no pain, no gain' process," Wang said.
Other credit problems may be lurking in harder-to-read areas such as
bank loans. News last week that a Chinese property developer owing
3.5 billion yuan was at the edge of insolvency highlighted that
risk. About a third of Zhejiang Xingrun Real Estate Co's borrowings
came from individual investors.
While the better known property developers have access to offshore
markets, there may be more casualties among the smaller players.
"Banks in any case aren't eager to provide loans and trust loans are
under scrutiny so the channels for smaller developers are limited,"
said Manjesh Verma, Credit Agricole head of credit research and
strategy in Hong Kong.
Some 80 percent of China's 60.3 trillion yuan in total corporate
debt comes from bank loans. Trust loans and microcredit accounted
for 4.8 trillion.
China's big banks favor large, state-connected firms, which leaves
smaller companies more reliant on informal lending.
"Do we see more defaults in the near future? Yes, with a move
towards market-based pricing that is inevitable but, in the near
term, the scale of defaults will be relatively small and this
process will be managed throughout the process," said Mark Capstick,
a fund manager at FFTW in London.
($1=6.1965 yuan)
(Additional reporting by Grace Li in Hong Kong, Adam Rose in Beijing
and the Shanghai newsroom: editing by Emily Kaiser)
China's first-ever domestic bond default this month — a missed
interest payment from Shanghai Chaori Solar Energy Science and
Technology Co <002506.SZ> — shattered the belief that Beijing would
always bail out struggling companies.
