China Private Bond Faces Stress as LGFV Says No Pledge

China’s private bond market is facing increased scrutiny after a local-government financing vehicle in the eastern province of Jiangsu said it has no obligation to guarantee notes sold by a manufacturer.

Dongfei Mazuoli Textile Machinery Co., based in the city of Dongtai, can’t pay principal and interest on the securities as of Jan. 25, according to a report today on Tencent Holdings Ltd.’s QQ.com. The LGFV had signed a contract with the manufacturer in 2012 to guarantee its bond credit ratings, but doesn’t guarantee the note payments themselves, according to a statement from the financing unit dated Jan. 26.

China has banned individual investors from buying bonds issued by small and medium-sized enterprises through private placement as the world’s second-biggest economy faces rising corporate default risks. Suqian Chief Leather Co., a leather maker also based in Jiangsu, has said it won’t be able to pay noteholders who exercise a Feb. 5 sell option on its 150 million yuan ($24 million) of three-year private securities due to a cash shortage, according to people familiar with the matter.

“Onshore investors have become more sensitive to credit risk these days as they are noticing the continued slowdown in the economy,” said Liang Zhong, sovereign and international public finance ratings analyst at Standard & Poor’s. “The incident shows the relationship between LGFV guarantors and issuers can be quite opaque and lacking in clarity, which increases the uncertainties for bondholders regarding repayments.”

Suqian Chief

A call to Dongtai Transportation Investment Construction Group Co., the LGFV, went unanswered.

A person who answered the phone at Dongfei Mazuoli who gave his surname as Wang said the manufacturer is doing over-the-counter settlements with noteholders and will pay the principal and interest in the near future.

Suqian Chief Leather has asked investors not to sell back notes early, the people said today. The company promises to pay back principal and interest when the securities come due in 2016, according to the people.

Calls to the manufacturer went unanswered. The line at Sino-Capital Guaranty Trust, the guarantor for the notes, was busy when called.

The cases are not the first for Jiangsu. The guarantor of debentures sold by Xuzhou Zhongsen Tonghao New Board Co. stepped in to help after the building-materials producer based in the province missed a coupon payment in March 2014.

Defaults Eyed

Shi Lei, head of fixed income research at Ping An Securities Co., said last month that defaults in the private bond market may increase this year. That’s because Chinese companies’ credit profiles will worsen even after the central bank cut interest rates, he said.

China started its private junk bond market in June 2012 to give small companies a way of raising funds outside the network of so-called shadow banks. Borrowers sell the notes directly to institutional investors in the market, unlike with publicly auctioned securities.

“For those opting to issue debt in the private market, there are greater chances that the underlying credit story for those issuers is quite complicated,” said S&P’s Zhong.

— With assistance by Qi Ding, Lianting Tu, Shuqin Ding, and Xize Kang

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