China Debt Markets Show Stress Amid Duck Supplier's Default

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China’s debt markets signaled more stress as a duck processor cited increasing difficulty getting credit as it defaulted on bank loans ahead of a bond deadline next week.

Zhong’ao Holdings Group Co., a closely held maker of smoked duck leg and other foods, owes banks 295.96 million yuan ($47.7 million) in loan principal and interest, according to a statement dated June 1 on Chinamoney. The company, based in the eastern province of Shandong, must repay 200 million yuan of 7.39 percent notes on June 12.

Just as Premier Li Keqiang is stepping up efforts to get more funds to smaller companies as economic growth slows, banks are balking. They have reduced lending for four straight months after bad loans jumped last quarter to the worst since 2008. China’s junk bonds were rattled last week after a bottle maker became the fourth company to default on local notes.

“Banks are now cautious and think it’s better to put their excess cash with the central bank than putting more money into the real economy,” Xuanlai He, a credit analyst in Singapore at Commerzbank AG, said by phone. “We can expect to see more defaults especially among the small- and medium-sized enterprises, which means there’s new emphasis on credit differentiation.”

Defaults Spread

An official at Zhong’ao who wouldn’t give his name declined to comment on the company’s debt repayment due next week.

Zhuhai Zhongfu Enterprise Co., a bottle maker in China for Coca-Cola Co. and PepsiCo Inc., repaid only 35 percent of the 590 million yuan principal for securities that fell due last week. In April, Cloud Live Technology Group Co., a restaurant operator-turned-Internet firm, failed to meet bond obligations and Baoding Tianwei Group Co. became the nation’s first state-owned enterprise to default on domestic debt.

In a sign that the stresses are affecting fundraising elsewhere, Hebei Iron & Steel Group Co. canceled a 1.5 billion yuan offering of debt that had been scheduled for June 1 citing market volatility, according to a statement to Chinamoney.

Defaults are spreading after Shanghai Chaori Solar Energy Science & Technology Co. last year became China’s first to miss payments on onshore bonds. Foreign investors are increasing scrutiny after Kaisa Group Holdings Ltd. became the first Chinese developer to default on its U.S. currency debt in April.

Yields Jump

Zhong’ao owed overdue loans to 13 banks, including three of the nation’s four biggest state lenders: Bank of China Ltd., Agricultural Bank of China Ltd. and China Construction of Bank Corp., according to the June 1 statement.

The yield on Zhong’ao’s commercial paper due June 12, which was sold last June, has surged 690 basis points this year to 14.3 percent. The company also has 100 million yuan of private bonds with a coupon of 8.5 percent due Oct. 8.

China Chengxin International Credit Rating Co. on May 11 lowered Zhong’ao Holdings’ rating to BB from AA- and cut the bond’s rating to B from A-1 , saying the company is “very short of capital.” The credit assessor said the duck manufacturer’s repayment ability has weakened significantly and that has limited external support.

“Since the second half of 2014, because of the slowing economy, sliding demand and increasing competition and more cash used as a result of company expansion, the company has been short of operating cash flow,” Zhong’ao said in a separate statement dated May 20. “Some financial institutions have curbed credit to our company, which resulted in our continued capital shortage.”

In April, Zhong’ao delayed release of its results for 2014 and for the first quarter of 2015. It had a profit of 388.73 million yuan for the first nine months of last year, compared with a 273.02 million yuan profit a year earlier.

The culling of weaker borrowers in China as the government allows market forces to play a greater role in finance means that stronger companies will receive lower borrowing costs while weak ones struggle to roll over loans, according to Commerzbank’s He.

“In the short term, this will impact the banks’ profitability,” He said. “In the long run, they will get to clean up their book of bad loans.”

— With assistance by Judy Chen, and David Yong

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