China’s first junk bond default highlights risk

A manufacturer of construction materials has become the first Chinese company to default on a domestic junk bond, a state-owned Chinese newspaper said on Tuesday, compounding investor concerns over which mainland issuers could be next to miss debt repayment obligations.

Xuzhou Zhongsen Tonghao, based in the prosperous but highly indebted province of Jiangsu, was unable to meet interest payments on Rmb180m (US$29m) in bonds it sold to domestic investors last year, according to the 21st Century Business Herald, a state-owned newspaper. The missed interest payment was estimated at Rmb18m, given the 10 per cent coupon on the bond, and took place last Friday.

The missed payment, if confirmed, would become the second default in three weeks in China’s Rmb8.5tn onshore corporate bond market following the failure of Shanghai Chaori Solar Energy to make an Rmb89.8m payment on an Rmb1bn bond in March. Chaori’s bond, unlike Xuzhou Zhongsen’s, was not classified as junk.

More important, investors said, is the impact that the defaults are having on sentiment toward other bond issuers of dubious financial health. Many, like Xuzhou Zhongsen, are in the property and construction sectors and thus vulnerable to sharply slowing property sales and a shakedown in the shadow finance system.

Data from 42 cities monitored by China Confidential, a research service at the Financial Times, showed that property sales volumes during the first 23 days of March were down 34 per cent from the same period a year earlier.

Bond investors are already exhibiting crumbling confidence toward a few developers that have issued bonds in Hong Kong. Glorious Property and Hopson Development Holdings, which have a combined US$1.3bn in bonds, were already trading at distressed levels with yields of 24.5 per cent and 12.4 per cent respectively on Tuesday.

Wuzhou International Holdings and Modern Land were two other mainland developers with bonds in Hong Kong trading at distressed levels, the threshold for which is 10 percentage points above similar-maturity US treasuries.

According to Moody’s, the rating agency, one of the key vulnerabilities of Chinese property developers is their exposure to high interest trust loans absorbed from the mainland’s shadow finance system (see table). Eighteen companies owing $15.2bn to bondholders have “material exposure” to trust financing in excess of 10 per cent of their total debts.

Source: Moody's

“The liquidity of these companies will be under pressure if they’re unable to either roll over their trust loans or raise frunds from alternative channels if their access to trust loans tightens amid increasing concerns about borrowers defaulting on these loans,” Moody’s said in report.

“Over the longer term, if the trust loan market remained closed to property developers, it would reduce funding channels for land acquisition and other needs,” it added.

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Related reading:
Slump in China property sales adds to default concerns, beyondbrics
Debt troubles within the Great Wall, FT
China’s shadow banks at risk of a property crash, FT