China’s Bailout Window May Shut in Three Months, OCBC Says

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China will likely prop up bondholders in any onshore defaults until August to ensure a smooth clean up of its local debt mess, according to Oversea-Chinese Banking Corp.

Events this year have defied Chinese rhetoric on embracing market-based reforms, after authorities passed up chances to make investors stomach losses from two local defaults, the bank wrote in a report Monday. This week sees a potential third missed payment after beverages bottle maker Zhuhai Zhongfu Enterprise Co. said it can only partly pay principal due May 28.

Forcing investor losses may sour market sentiment and hinder the successful completion of state efforts to clear a debt pile issued by provincial cities, according to OCBC. Banks must swap out 1 trillion yuan ($161 billion) of high-cost local government bonds issued by 36 Chinese cities for municipal debt with lower coupons by the end of August, it said.

“Onshore investors remain unfazed despite the two defaults,” Nicholas Koh, a credit analyst at the Singapore-based bank, wrote. “In terms of when China might allow bondholders to tolerate losses, the authorities might just have to wait till the end of August for a suitable opportunity.”

The People’s Bank of China may coordinate loan support for Baoding Tianwei Group Co. after it became the first state-owned entity to default on a coupon payment in April, OCBC said, citing local media. Restaurant-turned-Internet firm Cloud Live Technology was the first onshore issuer to miss a principal payment in April and has raised funds from “unclear” sources to partly repay noteholders, OCBC said.

Zhuhai Zhongfu, based in the southern city of Zhuhai, is still short 442 million yuan for a bond payment due Thursday, the company said in a statement to the Shenzhen stock exchange Monday. It will try to raise more money by May 26, it said.

Guarantees Please

Narrowing spreads on onshore bonds suggest investors are still counting on state guarantees, said OCBC, which compared Baoding’s situation with bailouts last year for Shanghai Chaori Solar Energy Science & Technology Co. and a trust product known as China Credit Equals Gold No. 1. The difference between AAA and BBB+ rated yields has fallen to 933 basis points from 942 at the start of the year, while the gap between AAA and AA notes shrank to 114 from 129, according to the report.

“China has a lot of bonds maturing this year and many of their issuers have weak credit strength,” said Zhang Li, a bond analyst at Guotai Junan Securities Co. in Beijing.

Another Default?

Chinese companies must repay an equivalent $16.9 billion of maturing onshore notes in 2015, Koh estimated in the report. That increases every year and will peak at $192.3 billion in 2021. Some 65 percent of institutions expect at least one more onshore default this quarter, according to a Bloomberg survey of 20 banks, brokerages and money managers published on May 18.

Still, there remains a sense that China will have suitable policies to balance growth and reforms even as the bond market seems to be running into a “perfect storm” of slowing economic growth, a clampdown on corruption, weakening real-estate investment and rising defaults, said Koh.

“The government is likely to maintain a cautious stance on defaults of large monetary values, those that involve large corporates in strategic sectors, and/or those that hurt a large number of retail investors in the near term.”

(A previous version of this story incorrectly stated PBOC coordinated loan support for Cloud Live after its missed payment.)

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