How debt the risks grow, here is 3 warning signs to watch

Illuminated signage at the headquarters of China Huarong Asset Management Co. on Financial way in Beijing, China, on Wednesday 19 May 2021.

Yan Cong | Bloomberg | .

BEIJING – Weak points emerge in China is growing debt pile.

National debt the levels have climbed to nearly four times of GDP, while an increasing number of corporate bonds are gone in default in the last 18 months.

although the latest the default values ​​represent a fraction of China’s 13 trillion dollar onshore bond market, some high-profile cases have rocked investors since common the perception was that the Chinese government it will not allow state-supported enterprises fail.

The case of Chinese bad debt manager Huarong has also scared investors, causing a market defeat this year when the firm failed file his earnings in time and its US dollar denominated bonds plummeted.

Analysts said cases like these signal how the so-called implicit of the state guarantee is changing as the government try to improve the bond market’s quality – weeding out weaker firms, and permitting for some differentiation within the sector.

Like China growth slows, authorities are trying to find a better balance between keeping control and allowing some market-guided forces in the economy in to support growth in the long term.

In first half of This year, the total number of corporate bonds in default in China amounted to 62.59 billion yuan ($ 9.68 billion), the highest for the first half of a year since 2014, according to Fitch Ratings data. Of this, the defaults of state-owned companies contributed to more of half that amount – about 35.65 billion yuan.

For the whole of 2020, bond defaults amounted to 146.77 billion yuan, a huge leap in forward just six Years ago in 2014, according to Fitch. That year, delinquencies totaled 1.34 billion yuan and there were no defaults by state-owned companies, the rating agency said.

While investor fears increase upHere are three important developments to watch, economists say.

1. Default of obligations in a gray area of Local government

An important milestone to counter the idea of implicit guarantee in of China market it would be a flaw of a bond issued by a local government financing vehicles (LGFV).

These companies are usually wholly owned by local and regional governments in China, and they were set up finance public infrastructure projects. Bonds issued by these companies increased in amid an infrastructural push while the Chinese economy improved.

“Many LGFVs are even worse than the so-called Zombie companies, in the sense that they could not pay interest, not (to) mention the principal on just right, ”said Larry Hu, Macquarie’s chief Chinese economist in a note dated 25 June. Zombie companies are the ones that are heavily indebted and reliant on loans e government subsidies to stay in life. “They could only survive because of the support of governments “.

“The year of 2021 is an implicit window to break guarantee, How is the first time in a decade in politicians don’t have to (to) worry about GDP growth target. As a result, they could tolerate more credit risk”Hu said, noting that it’s just a question of time before a default of the LGFV bond occurs.

In 2015, electric equipment the manufacturer Baoding Tianwei became the first state-owned enterprise by default on his debt, following the first default in The modern Chinese onshore bond market a year before.

Nomura said LGFVs are a “prime target” of The tightening of China drive, and noted that bonds issued by the sector rose to record 1.9 trillion yuan ($ 292.87 billion) last year, from just 0.6 trillion yuan in 2018.

2. of Huarongbig boss’ on the sector

For investment grade bonds in China, an important factor for future performance is how the case of Huarong Asset Management has been resolved, Bank of American analysts said in a note last month, defining the situation a “big ledge. “

The largest in China manager of bad debt, Huarong, it was struggling with failed investment and a case of corruption involving his own former president, who was sentenced to death in January.

After missing the March deadline to post his 2020 results, the company also She said “the auditors need more information and time for complete” the audit procedures. is added, however, that failure provide the results it is not a default.

Huarong’s biggest supporter is the Ministry of Finance. of China economy want need grow fast enough from ensure the central government budget it is not further strained.

If there is a messy default of by Huarong dollar bond, we may see a large sale off of Chinese credits, in particular credits (investment grade).

If Huarong’s case is solved with government support, is should raise China asset management sector, as well as other Chinese government- related entities, says Bank of America.

however, the bank added: “If there is a messy default of by Huarong dollar bond, we may see a large sale off of Chinese credits, in particular credits (investment grade) “.

Regulators are pushing Huarong to sell non-core assets as a part of a revamp, according to a Reuters report in early June.

In event of a default Huarong, the, cost of capital could rise “in meaningfully ” for other state-owned companies such as “markets re-evaluate perceptions” of implicit guarantees from the state “, Chang Wei-Liang, macro strategist in Singapore bank DBS, he told CNBC via e-mail. How are the risks up, companies have to offer higher returns to attract investors.

Chang said China has had enough money on hand to turn to Huarong problems.

However, the key the question is whether the state will choose to do so intervene by providing support with additional capital, or by imposing losses on shareholders e debt holders first strengthen market discipline “, has added.

3. Weak points in some provinces and local banks

In an effort to find out where potential hot spots for SOE defaults could be, S&P Global Ratings analysts found that small concentrated banks in north and south-central China face deteriorating asset quality.

“City and rural commercial banks with problem loans exceeding the media of the sector are expected to off Chinese Renminbi (RMB) 69 billion in these loans to bring their ratio to average sector levels, with those in the worst northeast hit”, reads the report of 29 June.

A fiscally weaker province is likely linked to a less dynamic economic situation, (and) a weaker economic situation means that there may be more default of corporate bonds.

Francoise Huang

senior economist, Euler Hermes

This could affect the ability of small banks a support local state-owned companies, which may require larger banks to step in to maintain system stability, the report states.

The provinces with major problems are those exposed to cyclical sectors, to S&P Global Ratings credit analyst Ming Tan told CNBC.

Authority need find a balance between allowing lower quality loans to have a riskier credit rating and maintaining problems from acceleration, Tan said. “There certainly is risk of bad management in course down the road, but so far, what we are seeing is that it has been managed quite well. “

This was revealed by the Chinese banking and insurance regulator last week that in 2020, the banking sector sold of a record high 3.02 trillion yuan – or $ 465.76 billion – in not performing assets. Other data released last the week showed that China’s GDP grew by 7.9% in the second quarter from a year ago, a touch below expectations.

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Some analysts have reported local weaknesses. Precise analysis of resource management found that consumption declined year-on-year in May for four provincial capitals: Wuhan, Guiyang, Shijiazhuang and Yinchuan.

“A fiscally weaker province is likely linked to a less dynamic economic situation, (and) a weaker economic situation means that there may be more corporate bond default, “said Francoise Huang, senior economist at Euler Hermes, a subsidiary of Allianz.

The longer-term issue is renovating economy of these weaker provinces a allow more dynamic ones to grow, he said. “I don’t think the solution would be to (continue) investing in these less performing sectors just for good of keep them in life”.

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