How Defaults in China Are Reshaping Its Credit Market: QuickTake

(Bloomberg) -- Chinese policy makers have long sought to liberalize the nation’s credit market by allowing more defaults, to disabuse investors of the notion that some companies are too big to fail. They’ve delivered in a major way in 2021. Debt failures have surged to a record after the government cracked down on speculation and excessive leverage in the real estate industry, leading to stumbles at a string of indebted property giants including China Evergrande Group. The result has been a repricing of risk in credit markets. Offshore borrowing costs for riskier Chinese firms surged to unprecedented levels, discouraging the kind of debt-fueled expansion that could threaten the financial system and President Xi Jinping’s grip on power. 

1. How bad has it got? 

Chinese borrowers defaulted on a record $42 billion of onshore and offshore bonds in the year to mid-December, up from a total of $30.2 billion in 2020. That month was poised to be the worst ever for Chinese offshore corporate defaults, even after regulators urged borrowers to to honor offshore debt obligations. More credit risk was simmering, with several property developers including Guangzhou R&F Properties and RiseSun Real Estate Development scrambling for ways to delay payments in 2022. Even firms that were long seen as safer, such as Shimao Group Holdings, have been trying to dispose of assets at a loss to raise much-needed cash. 

2. Which sectors were most affected? 

Real estate accounted for around half of Chinese offshore defaults in 2021, according to data compiled by Bloomberg, including large borrowers such as Evergrande and Kaisa Group Holdings Ltd. Airlines and electronics are two other sectors hit hard by defaults. Historically, defaults have been mainly confined to the private sector. But since late 2020, state-linked companies like Tsinghua Unigroup Co. as well as state-owned bad debt manager China Huarong Asset Management Co., also ran into trouble, although the latter avoided an outright default with a state-led rescue.

3. How did we get here?

Chinese companies have been piling on debt for at least a decade, ever since the leadership team under Xi’s predecessor responded to the 2008 global financial crisis by going on a borrowing binge. That kept China’s economy chugging along, but at a cost. The corporate debt to GDP ratio surged to a record 160% at the end of 2017, from 101% 10 years earlier. Xi and his lieutenants vowed to rein it in, issuing directives on how money was to be loaned and managed. Tightened regulations constrained some borrowers’ ability to binge on new debt to refund old ones. Failed payments picked up pace in October, following a surprise default from Fantasia Holdings Group Co. just days after the firm assured investors of its ability to pay.

4. What’s been the fallout? 

The latest wave of defaults has shaken investor confidence and pushed costs for lower-quality issuers to records, severely constraining their access to funding, which in turn heightens the risk of failed payments. Investors have been reassessing risks, with appetite for new Chinese dollar bond offerings waning and demand falling in the broader Asian credit market. They’ve also grown more skeptical about the quality of Chinese issuers’ financial reporting. The swirling credit crisis is seeping into the wider economy, dragging down home sales and prices and threatening to worsen an economic slowdown. It’s even prompted worries from the U.S. Federal Reserve about potential risks to global markets and growth. 

5. What’s the government’s challenge?

The government tried for years to rein in reckless borrowing that could trigger a financial meltdown, but fear of pushing the economy off the rails prevented it from taking more decisive action. Maintaining a stable economy will be a top priority in 2022, when the Communist Party is expected to reshuffle its leadership and hand Xi an unprecedented third term in office. 

6. So what is the government doing? 

Policy makers have taken a targeted approach by focusing on problem debt in the property sector. The industry has been left out of post-pandemic economic stimulus measures, and the government has introduced three red lines -- metrics on debt -- that developers have to meet if they want to borrow more. Conscious that its bad-debt crackdown could hit responsible borrowers too, Beijing cut official borrowing rates in December to give companies more breathing room. It’s also been trying to avoid state bailouts that might be perceived as a reward for bad behavior. The government has sought help on credit analysis from some of the international rating firms favored by overseas money managers, and offered U.S. investors greater access to the potentially lucrative pool of soured debts. The hope is that, once the tide of defaults ebbs, it will leave behind a more disciplined, efficient market.

7. How does bankruptcy work in China?

Troubled companies get as long as nine months from when the court accepts a filing to submit a restructuring plan to creditors, who then have as many as 30 days to vote on it. If it isn’t accepted, the company can be declared bankrupt, triggering liquidation. In practice, the process can drag on beyond nine months and foreign investors have had limited enforcement rights on some state-owned assets, according to Pacific Investment Management Co. Concerns exist about the government’s heavy involvement in major restructuring cases and the reluctance of banks to pursue court-supervised plans because they don’t want to bear losses. On the other hand, foreign investors are getting improved access to assets of bankrupt firms in mainland China under a new agreement between Beijing and Hong Kong. The pilot program allows courts in Shanghai, Shenzhen and Xiamen to recognize insolvency proceedings in Hong Kong.

The Reference Shelf

• QuickTakes on hidden debt and rating companies in China and the “three red lines” for property developers.
• Bloomberg Opinion’s Shuli Ren probes the impact of serial corporate defaults.
• Bloomberg Intelligence investigates the currency risk facing China’s property developers.
• A BNP Paribas blog on Beijing’s difficult balancing act on debt reform.

©2021 Bloomberg L.P.

With assistance from Bloomberg