Chinese State Firms Shape Roadmap to Fix Offshore Bond Mess

(Bloomberg) -- A formula is emerging for Chinese state-run firms to resolve offshore debt failures after a major commodities trader and a prominent aluminum producer imposed nearly identical losses on holders of their defaulted bonds.

The decisions by Tewoo Group Co. and Qinghai Provincial Investment Group Co., which have since December committed the two biggest dollar-bond defaults from China’s state sector in 20 years, could offer a roadmap to investors as Beijing allows more ailing state firms to go bust.

The development also comes as Chinese policymakers explore ways to ensure more orderly bond defaults now that a weakening economy and trade tensions have unleashed a record wave of debt failures. That’s made worse by the coronavirus outbreak that has darkened even more the prospects for distressed borrowers.

Chinese State Firms Shape Roadmap to Fix Offshore Bond Mess

Qinghai Provincial, a troubled state-run aluminum maker from the northwestern province of Qinghai, Wednesday offered holders of $850 million worth of defaulted bonds to sell their notes at discounts as deep as 63%. That resembles a key element in the debt plan of Tianjin-based Tewoo Group which in December became the largest offshore bond defaulter among state-run companies in two decades.

Commodities trader Tewoo set a precedent among its peers by also offering haircuts as much as 63% to its dollar bondholders. It also gave investors the option of swapping their bonds for new ones with substantially lower coupons issued by its offshore debt manager.

“The bond repayment plans by Qinghai Provincial and Tewoo are quite similar, which means more Chinese companies may follow this model in the future,” said Ivan Chung, a Hong Kong-based analyst at Moody’s Investors Service.

The 40% or so recovery rate for investors is higher than that of defaulted bonds in China’s domestic market and is likely acceptable to investors, Chung said. “If offshore investors don’t accept restructuring and seek bankruptcy proceedings or other means, it will be more time and energy consuming,” he added.

Tewoo Inspired

Qinghai Provincial’s repayment offer “makes sense” because the proposed haircut is in line with the bonds’ current market value and the average global corporate debt recovery rate, said Angus To, Hong Kong-based deputy head of research at ICBC International Holdings.

Likely inspired by Tewoo again, Qinghai Provincial uses the subsidiary of another major local state-run firm to manage its offshore debt and buy its bonds back from investors. In Tewoo’s case, it is a state asset manager from Tianjin that was appointed to clean up the commodities trader’s dollar bond mess.

The dollar debt failures of Tewoo and Qinghai Provincial, the two biggest for Chinese SOEs since the collapse of Guangdong International Trust and Investment Corp. in 1998, is a sign that the worst economic slowdown in three decades is limiting Beijing’s capacity to bail out its weaker state firms.

“To investors, whether onshore or offshore, the government’s implicit support for SOEs isn’t 100% and their investment may face big losses,” said Chung of Moody’s.

Future Protocol

Cases like Tewoo and Qinghai Provincial indicate the governments’ growing tolerance for SOE defaults in both the onshore and offshore markets, and “their willingness to adopt market-driven debt restructurings of stressed SOEs rather than unconditional bailouts,” said Li Chang, an analyst at S&P Global Ratings.

In response to two consecutive years of record onshore bond defaults, Chinese regulators have in recent months taken steps aimed at establishing a system to handle the bond mess more efficiently and transparently.

“This is a healthy development to the bond market in the long run, that the government is allowing higher default rates as they want to let the market play a bigger role in discerning risk,” said Agnes Wong, head of Asia Credit Strategy & Trading Desk Analysts at BNP Paribas SA.

The future protocol taking shape via Tewoo’s and Qinghai Provincial’s examples has implications not only for SOEs but also for China’s struggling private firms, the dominant force in the country’s growing legion of debt defaulters.

“More privately-owned enterprises may also follow this practice and we believe this is in line with the authorities’ aims of allowing more bond defaults to facilitate more efficient risk pricing and promote credit differentiation,” said ICBC International’s To.

©2020 Bloomberg L.P.

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