Another Week, Another Chinese Default

– Another Chinese High Yield Bond Issuer Declares Bankruptcy (ZeroHedge, April 9, 2014):

Another week, another Chinese default.

A month after Chaori Solar’s default turned on its head a long-held assumption that even high-yielding debt carried an implicit state guarantee, another Chinese firm has succumbed to the inevitable outcome resulting from a lack of cash flows. As a reminder, a technical default late last month by a small construction materials firm, Xuzhou Zhongsen Tonghao New Board Co Ltd, was the first in China’s high-yield bond market. However, in that case the guarantor of that bond eventually agreed to fund the required interest payment, resulting in the first bailout of the first high yield default. Still if Xuzhou didn’t want the distinction of the first Chinese HY default, many are lining up for that particular prize – such as a small manufacturer of polyester yarn based in China’s wealthy Zhejiang province has declared bankruptcy, threatening its ability to meet an interest payment on a high-yield bond due in July.

According to Reuters, the firm sold 60 million yuan ($9.7 million) in bonds in a private placement in January 2013 at an interest rate of 11 percent. The next interest payment is due on July 23, while the bond matures in January next year.

Reflecting the government’s new attitude towards default, the China Securities Regulatory Commission (CSRC) described the Xuzhou Zhongsen default as a commonplace event.

“(The Xuzhou Zhongsen bond) was issued to investors according to regulations, and the default is an isolated risk event. The commission will abide by market-based principles and handle the case according to law,” CSRC spokesman Deng Ge said at the agency’s weekly press conference on Friday.

And it is no secret that as the weeks keep rolling in, so will many more defaults:

Analysts widely expect more defaults on loans, bonds, and shadow bank products this year. Semiconductor, software, and commodities firms are among the most at risk for default, a Reuters analysis of more than 2,600 Chinese companies showed.

The Xuzhou Zhongsen default marked the first ever in China’s high-yield bond market, which the securities regulator launched in June 2012 in a bid to offer a new financing channel for small, private firms. Such firms often struggle to access credit in China’s state-dominated financial system. Zhejiang Huatesi’s bond was also issued in that market.

Pengyuan Credit Rating Co Ltd gave Zhejiang Huatesi Polymer’s bond an A+ rating when it was issued. That is among the lowest ratings at which bonds are commonly sold in China’s market.

Naturally, there is the possibility that this too bankruptcy will be delayed by a post-last minute payment by the guarantor, another polyester firm.

An executive at Dongguan Securities Co Ltd, which served as underwriter on the bond, told Reuters on Tuesday that the guarantor on the bond is likely to meet its obligation to make interest and principal payments if the issuer is unable to do so.

The bond carries an unconditional guarantee by Tianlong Holding Group Co Ltd, another polyester firm in Zhejiang. It is also secured by land rights owned by the company and personal assets owned by the controlling shareholder, the underwriter said.

“There are various different reasons (for Zhejiang Huatesi’s problems). Factors affecting that sector, the influence of industrial restructuring, etc,” the executive said.

Still, even with a bailout, the scariest thing is that the value of the assets backing the bond at the originator level is a resounding zero: “The phone number on Zhejiang Huatesi’s website has been disconnected, according to an automated message.”

Expect many more phone disconnections in China as the biggest ever Minsky moment begins to unwind.