China’s Latest Default Dodge Helps Cut Borrowing Costs

Corporate borrowing costs in China fell the most in a week after the country averted the second default in its onshore bond market, fueling speculation the government is prioritizing market stability over liberalization.

The extra yield over sovereign notes AAA-rated companies pay to sell one-year notes fell three basis points yesterday to 114 basis points, the biggest decline since July 16, according to Chinabond data. Huatong Road & Bridge Group Co., based in the northern province of Shanxi, yesterday paid all principal and interest on a bond it just last week had warned it may fail to repay, according to four people familiar with the matter.

While Premier Li Keqiang has pledged to allow the markets to play a bigger role in the economy, Huatong’s last-minute payment follows similar cases this year as the government aims to bolster slowing economic growth. Building-materials maker Xuzhou Zhongsen Tonghao New Board Co. averted a default in China’s private junk-bond market in April after its guarantor paid up, and investors in a product arranged by China Credit Trust Co. were bailed out in January days before it came due.

“The local government probably repaid the accounts receivables they owed Huatong,” said Shi Lei, the head of fixed-income research at Ping An Securities Co., a unit of the nation’s second-biggest insurance company. “They knew that if the company had defaulted, it would have had very bad impact.”

Safeguarding Stability

Short-term borrowing costs leapt by the most in eight months last week after Huatong flagged in a July 16 statement it may have trouble meeting its financial obligations. One-year top-rated commercial-paper yields rose 26 basis points to 4.957 percent. After the company repaid the 400 million yuan ($65 million) of notes yesterday, the yields dropped 3 basis points to 4.917 percent.

Huatong had been making efforts to raise the funds, with help from local governments and bond underwriters, company official Geng Naizhuang said by phone July 18. An official at the company today declined to comment on the source of the funds when asked about the repayment, and wouldn’t give his name.

As the government tries to safeguard stability, it’s unlikely there will be defaults among publicly traded bonds like Huatong’s, according to Ping An’s Shi.

Balancing Risks

Shanghai Chaori Solar Energy Science & Technology Co. was the first to default on onshore bonds in March when it didn’t meet part of an interest payment on 1 billion yuan of notes on the exchange-traded market. Huatong’s securities, in contrast, were on the interbank market, the country’s biggest bond bourse.

China’s policy makers are trying to balance the risk of letting weaker companies fail with steps to ensure stability in the nation’s $4.2 trillion bond market. Chinese firms have the most debt globally after increasing borrowings to $14.2 trillion as of Dec. 31, surpassing the U.S.’s $13.1 trillion, Standard & Poor’s said in a June 15 report.

Premier Li has unveiled measures which may help avert collapses in one of China’s most leveraged sectors, real estate, in May introducing central bank loans for low-income housing and lowering reserve requirements for some qualified banks.

“A company won’t default when both local governments and banks try to save it,” said Yang Feng, a bond analyst in Beijing at Citic Securities Co., the nation’s biggest brokerage.

Financial Strains

At the same time, China will experience more companies like Huatong running into repayment difficulties as the economy slows, he said.

Growth in China is set to cool to 7.4 percent this year, the slowest in more than two decades, according to the median estimate in a Bloomberg survey. The government is aiming for expansion of about 7.5 percent, and fourteen of 22 respondents to a Bloomberg survey this month said it will need to “somewhat” increase stimulus to meet that goal. President Xi Jinping said in May the government will pursue growth and reform, while preventing risks in order to preserve social stability.

The reaction in the weeks after Chaori’s default was more muted with yields climbing 21 basis points to 5.31 percent in the five days ended March 21. Chaori missed its payment March 7 and has since had a restructuring application accepted by a Shanghai court.

A Huatong default would have differed from Chaori’s in that it would have been the first company to fail to pay both a bond’s interest and principal, and also the first to default in China’s interbank note market.

Huatong isn’t the only company to exhibit financial strain since Chaori. Closely-held developer Zhejiang Xingrun Real Estate Co. collapsed in March. Notes sold by packaging company Zhuhai Zhongfu Enterprise Co. and solar-cell maker Baoding Tianwei Baobian Electric Co. were also placed in trading halts amid mounting losses.

“We don’t think this will be the last case of financially stressed companies coming to the bond market’s attention, especially from industries facing oversupply or high-leveraged issuers,” said Carter Liu, vice-president of credit ratings in Hong Kong at China Chengxin (Asia Pacific) Credit Ratings Co.

— With assistance by Judy Chen, and David Yong

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