Back-to-Back Defaults in China Shrugged Off in Credit Market

Just two months into 2021 some of the worst fears for Chinese credit are starting to flare, and yet you’d barely know it looking at the broader market.

Average spreads on Chinese 3- and 5-year top-rated notes over equivalent government notes have tightened recently, with the latter nearing the lowest since early 2020 on Wednesday, Chinabond indexes show. Gauges of local government financing vehicle bonds had spreads holding steady despite some weakness emerging among individual notes.

Debt investors barely blinked when stress flared up in two important sectors -- property and LGFV borrowers -- a sign that Beijing is managing to introduce greater market discipline and allow more firms to default without generating systemic risk which drags good credits down with the bad. China’s top banking regulator this week also warned about the need to reduce leverage amid the rising risk of bubbles globally and in the local property sector.

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Troubled real estate firm China Fortune Land Development Co. defaulted on a $530 million dollar bond due Sunday, and some holders said they failed to receive payment on a 2 billion yuan ($309 million) bond which matured Wednesday. Separately, local government-backed Chongqing Energy Investment Group Co. has failed to repay 915 million yuan of commercial bills due Monday, according to a person familiar with the matter who cited a company notice sent to a creditor committee.

“The credit events at Chongqing Energy and China Fortune Land Development are unlikely to create contagion risks that spread beyond the individual provinces where these firms are most exposed,” according to Dan Wang, a credit analyst at Bloomberg Intelligence. “For Chongqing Energy, the systematic risk is manageable as this firm has been a weaker SOE in the local region for some time, with only one public dollar bond and no public onshore bonds outstanding.”

Pockets of Risk

There are still signs of turbulence, though it has been largely limited to smaller groups of weaker borrowers. Bonds from other Chongqing-based LGFVs dropped Wednesday but have since steadied, Bloomberg-compiled pricing shows. Chongqing Nan’an Urban Construction & Development Group Co.’s dollar bond due 2026 rose 0.4 cent on the dollar to 92.8 cents Thursday after dropping 6 cents a day earlier.

Some of Yunnan’s state-linked firms also present a risk, according to a note from Nomura International HK Ltd. It’s “doubtful” that the offshore and onshore market will perceive “a complete isolation of risks” among three certain state-owned enterprises and LGFVs there given their similar bank support and large onshore maturities, wrote analyst Clare Guo.

In China’s offshore junk bond market, which is dominated by property firms, traders said average prices dropped about 0.25 cent Thursday while equity markets fell sharply. Average yields rose 0.2 percentage point to about 8% on Wednesday, remaining a touch below the measure’s 100-day moving average, according to a Bloomberg Barclays index.

Still, some analysts warn that China Fortune Land’s debt woes are the first casualty of Beijing’s tightening policy stance toward property developers, including the “three red lines.” That’s expected to weigh on weaker and highly leveraged borrowers.

©2021 Bloomberg L.P.

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