Latest China Bond Default Puts Spotlight on Financial Reporting

(Bloomberg) -- The Chinese company that defaulted on a bond on Tuesday reported cash levels just four months ago that were enough to pay the debt 15 times over.

Kangde Xin Composite Material Group Co., based in the eastern province of Jiangsu, failed to pay a 1 billion yuan ($148 million) local note due Jan. 15 due to a liquidity crunch, according to the company. Yet as of end-September, it had 15.4 billion yuan in cash and equivalents, more than double the amount of its short-term debt, according to regulatory filings.

The default raises questions about the quality of financial reports from Kangde Xin and also highlights risks of investing in junk-rated bonds from the country. The consequence is investors will tend to shun risky issuers or demand a higher premium just when Chinese cash-strapped firms need funding the most, according to Manulife Asset Management. A liquidity crunch in China already sparked record local bond failures in 2018.

"There have been too many companies with poor credit quality tapping the bond market in recent years,” said Jimond Wong, senior portfolio manager for Asia fixed income at Manulife Asset Management. “Very often, their problems are not easily captured by financial statements.”

Kangde Xin caught the attention of Chinese regulators last year. In May, the Shenzhen Stock Exchange asked the company to elaborate on its cash holdings which had jumped to 18.5 billion yuan at the end of 2017 from 10.1 billion yuan two years earlier. In October, China Securities Regulatory Commission launched an investigation into Kangde Xin on inadequate information disclosure on dealings among its shareholders.

On Wednesday, Kangde Xin’s credit rating was cut to Ca from B3 by Moody’s Investors Service to reflect the default and expectation of the “high economic loss for bondholders when compared to the original promises on payment.”

Read more: Analysts Sound Alarm on Financial Data After Kangde Xin Default

Kangde Xin referred Bloomberg News to its public statements when reached by phone on Wednesday. The company’s account receivable collection slowed since the start of October due to unfavourable financial market conditions, and its liquidity ran into temporary difficulties, the firm said on the Shenzhen Stock Exchange website on Jan. 15, in response to investor queries about its ability to repay the local bonds and whereabouts of its cash.

Kangde Xin "is a timely reminder that it is dangerous to stray too far into” lower rated Chinese names and private firms from the country still face rising default risks, said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group Ltd.

About a month ago, investors had a similar encounter with another Chinese junk-rated borrower called Reward Science and Technology Industry Group Co. The detergent and dairy producer reported having 4.15 billion yuan in cash and equivalents at the end of September before reneging on a 300 million yuan local bond payment in early December. Calls to Reward’s official in charge of bond information disclosure went unanswered.

"There are big issues with Chinese issuers’ financial disclosure and much more stringent regulation is need to change the situation,” said Lv Pin, a credit analyst at CITIC Securities Co. “Right now, investors can’t rely on issuers’ financial statements at all and some have even disregarded them altogether.”

To contact Bloomberg News staff for this story: Ina Zhou in Hong Kong at hzhou179@bloomberg.net;Carrie Hong in Hong Kong at chong61@bloomberg.net;Tongjian Dong in Shanghai at tdong28@bloomberg.net;Xize Kang in Beijing at xkang7@bloomberg.net

To contact the editors responsible for this story: Neha D'silva at ndsilva1@bloomberg.net, Lianting Tu

©2019 Bloomberg L.P.

With assistance from Bloomberg