(Bloomberg) -- China’s hidden debt risks are back in the spotlight this week.
A chemical maker in the eastern province of Shandong had trading of its bonds suspended amid uncertainty over its operating performance. That triggered a slump in the dollar bonds of a neighboring company that had guaranteed the other’s debt.
China’s privately held firms have relied on extending such guarantees for each other to entice banks, which otherwise prefer lending to state-owned firms, to offer them loans. It’s not the first time that the practice has had a domino effect. In March, concerns about such intertwined obligations, which are excluded from balance sheets, in the same province of Shandong caused a selloff of the region’s local corporate notes.
“It’s a lesson for offshore investors,” said Terence Cheng, deputy general manager and chief investment officer at HuaAn Asset Management (Hong Kong) Ltd. “They will be more careful with Chinese companies having debt cross-guarantees. After all, we are in Hong Kong. It’s hard to get timely information about what’s really happening onshore.”
The action this week unfolded more than 1,400 kilometers (870 miles) away from Hong Kong in a city called Heze, famous in China as a center for cultivation of the peony flower.
There, a company called Hongye Chemical Group Holdings Co., which also has a peony business, said Monday in an exchange filing that trading of its onshore yuan-denominated bonds would be suspended from Tuesday due to "big uncertainties" in its operating performance.
Financial stress has escalated at the company since April when a couple of onshore banks cut credit lines due to a combination of reasons, including general tightening credit conditions, Tony Chen, a credit analyst at Nomura Holdings Inc., wrote in a report Wednesday.
While Hongye itself didn’t elaborate in its statement this week, the whiff of trouble spread.
Another company in the same city, Shandong Yuhuang Chemical Co., guaranteed a total of 1.35 billion yuan ($200 million) of bond and loan debts of Hongye as of June 27, according to a China Lianhe Credit Rating Co. report this week. That connection was enough to send the yield on the 2020 dollar bonds of Yuhuang, whose chemicals are used in gasoline, up 232 basis points since Monday to a record high of 9.39 percent as of 5:23 pm in Hong Kong.
Zhao Dawei, who is in charge of Hongye’s information disclosure according to the company’s annual report, declined to comment. Two calls to Yuhuang went unanswered and there was no immediate reply to an email to the company.
In addition to the $300 million dollar bonds, Yuhuang has a total of 5.2 billion yuan of outstanding onshore yuan notes, 1.1 billion yuan of which will mature this year. Investors also have an option to sell 500 million yuan of securities back to the issuer in November.
Lianhe said Wednesday it will watch for possible repayment risks at Yuhuang. Any demand to support Hongye’s debt could put some pressure on Yuhuang’s cash position, according to Rick Mattila, international head of market strategy at MUFG Securities Asia Ltd.
The case highlights the broader issue of lack of transparency in China, which bond legend Bill Gross dubbed the “mystery meat" of emerging markets.
The amount of debt guarantees at privately held firms in the nation is equivalent to 11 percent of their equity, according to Citic Securities Co. Guarantors don’t mark the pledges on their balance sheets and often disclose them only on an annual basis. Such shadow debts pose rising risks after the government’s campaign against leverage pushed up borrowing costs.
Hongye also guaranteed 1.2 billion yuan of debt owed by Yuhuang and its subsidiaries as of the end of last year, according to the company’s annual financial report released this month. China Chengxin Securities Rating co. this week downgraded Hongye’s local credit rating to BBB- from AA, saying the firm hasn’t provided documents required for follow-on rating analysis.
With assistance from Judy Chen