China defaults feared as firms confront short debt addiction

[SHANGHAI] China's leverage crackdown is forcing local companies to confront their addiction to short-term bond sales that they use to roll over debt. The shock therapy is worsening the outlook for corporate defaults in the second half of this year after borrowing costs jumped to a two-year high.

With yields surging, Chinese non-banking firms sold 131 billion yuan (S$26.708 billion) of bonds with a maturity of one year or less in May, the least since January 2014 and less than half of the same month last year, according to data compiled by Bloomberg. About 87 per cent of the short note sales last month will be used for refinancing, according to Bloomberg data.

The habit of relying on borrowing short-term money to repay maturing debt has pushed up such liabilities to a total of 5.2 trillion yuan on China's listed non-financial companies' balance sheets as of March 31, the highest on record, according to data compiled by Bloomberg. With no sign of an end to the government's campaign against leverage, the average coupon rate for bonds maturing in one year or less rose to 5.5 per cent in June, deterring issuers from raising money to roll over debt.

"Small issuance of short-term bonds will be a normal phenomenon in the coming six months because cash supply will probably remain tight," said Ma Quansheng, Shanghai-based chief strategist at Fullgoal Fund Management Co, which oversees 186 billion yuan of assets.

"Both default risks and the number of corporate bond defaults may increase."

The loose funding environment last year helped Chinese companies raise enough money to withstand repayment pressure so far in 2017. There have been 13 onshore defaults in the public bond market in 2017, compared with 16 in the same period of 2016.

The yield on one-year AAA rated company bonds averaged 4.19 per cent this year, up from 2.97 percent in 2016. HFT Investment Management Co said more note defaults may come as the economy doesn't look good. In the second half of this year, Chinese non-banking firms must repay 2.36 trillion yuan of bonds, according to Bloomberg data.

"The current rising borrowing costs may have a big impact on companies' operations and finance," said Lu Congfan, a fixed-income assistant fund manager at HFT Investment Management.

"What can you do when you must refinance to repay maturing debt while facing such high borrowing costs? That would be a question challenging many local companies in the second half or next year."

Still, some firms are selling bonds despite the high yields. Xingjiang Guanghui Industry Investment Group, a AA+ rated automobile service provider, issued one-year bonds at a yield of 7.3 per cent this month, the highest among all notes maturing in one year or less.

Moody's Investors Service said on May 10 that Xinjiang Guanghui's short-term debt amounted to around 54 billion yuan as of Dec 31, well exceeding its cash holdings. Two calls to the firm went unanswered.

The worst issuers' liquidity problems are still worsening, according to China International Capital Corp. About 14.6 per cent of bond issuers' cash and cash equivalents is less than 30 per cent of their short-term borrowings as of March 31. The percentage is higher than the year-end level in 2015 and 2016, said CICC.

"Any temporary halt in high-leverage issuers' access to the short-term bond market could trigger more defaults," said Wang Ying, head of China research initiative at Fitch Ratings in Shanghai.

"The government is showing more tolerance for corporate defaults. But if there is any sign of regional risk, it may intervene to prevent default risks from spreading."

Chen Qi, chief strategist at private fund management company Shanghai Silver Leaf Investment Co, said the surging borrowing costs will make matters even worse for struggling companies.

"High-quality companies will still be able to borrow money from banks even if they cancel bond sales," said Mr

Chen in Shanghai.

"But it's difficult for lower-quality companies to get money elsewhere. They may face something bad down the road."

BLOOMBERG