MNI: More China SEO Dollar Defaults Seen As Maturities Bulge

More defaults on dollar bonds by Chinese state-owned enterprises may be on the way as borrowers face a bulge in maturities through to 2022, policy advisors and an analyst told MNI, adding that supervisors will continue to exert tight control over foreign borrowing by real estate companies and local government funding vehicles.

With policy makers gradually breaking with what was long perceived to be an implicit guarantee on SEO debt, companies' performance rather than their ownership will be the decisive factor for their payments, said Chang Shuyu, a research fellow at the Institute of World Economic and Politics under the Chinese Academy of Social Sciences. Oil and gas and transportation companies and local government financing vehicles as well as some property developers are likely to come under pressure after their debt expanded much more quickly than their overseas profits, she said, pointing to potential strains as USD150 billion in bonds come due this year and USD170 billion in 2022.

With much Chinese dollar debt now issued to roll over older bonds, tighter liquidity conditions in global markets or yuan volatility against the greenback would be significant risk factors in the second half of this year, she added.

Chang added that while officials are doing the right thing by moving towards market-oriented reform, regulators must still be wary of sparking systemic shocks, despite their ability to step in if sell-offs get out of hand.

HUARONG TURMOIL

Chinese corporate dollar borrowers missed payments at a record pace by both numbers and volume in 2020, and concerns over state-owned companies have risen further amid the turmoil engulfing distressed debt manager China Huarong Asset Management Co.

Four issuers have already defaulted on USD3.2 billion of dollar debt in the first four months of 2021, including Tsinghua Unigroup Co, a major chip company owned by Tsinghua University, said Zhang Shuncheng, associate director at corporate research at Fitch Rating.

Investors first began to take note of the authorities' determination to end the implicit guarantee for debt issued by state-owned companies in 2019, when Tianjin Tewoo Group made the biggest SEO dollar default in two decades.

Low-quality SOEs and medium-sized and small property companies are likely to represent the largest credit risk, according to Zhang. He noted, though, that if U.S. Treasury yields continue to rise, making dollar borrowing less attractive than yuan funding, new dollar debt is unlikely to grow fast, particularly given strict scrutiny on dollar bond issuance by property developers.

Given the rising risks, supervisors are closely watching new dollar borrowing by companies such as real estate firms and local government financing vehicles, said Xu Deshun, researcher at Chinese Academy of International Trade and Economic Cooperation under Ministry of Commerce.

Those borrowers who do manage to issue may also have to use currency swaps to hedge their risk, further increasing funding costs, said Shao Jinhong, executive director and CEO of China Chengxin (Asia Pacific) Credit Ratings Company Limited.

From January to April, non-financial entities issued a total of USD52.4 billion overseas, up 12% year-on-year, but property companies' issuance fell 23%, according to Zhang. Overall Chinese dollar bond defaults reached a record USD7.26 billion last year involving 12 companies, including Peking University Founder Group, Tsinghua Unigroup Co and Qinghai Provincial Investment Group, a vehicle established by the regional government of Qinghai.

LONG-TERM EXPANSION

Nonetheless, despite the risks, the longer-term prospect for Chinese dollar issuance remains one of expansion as the country opens its financial markets, given that it offers both an important channel for Chinese companies to obtain funding and an option for foreign investors looking for Chinese assets, Xu said.

China's outstanding offshore dollar bonds totalled USD822.5 billion as of the end of March 2021 from USD358.6 billion in 2016, noted Shao, adding that the market could receive further impetus from the expected launch in the second half of the year of a southbound expansion of Wealth Management Connect, allowing individual mainland investors living in the Greater Bay Area to invest in products sold by banks in Hong Kong and Macau.

Dollar bonds provide an attractive midpoint vis-à-vis China's strictly-regulated domestic bond market, Chang said, because it offers global institutional investors a convenient way of becoming acquainted with Chinese corporate borrowers before taking on yuan debt exposure.

China could follow the example of Japan, which first encouraged its companies to explore overseas debt markets before reforming its own domestic markets and rating systems, Chang suggested.