On September 8, 2019, a Chinese national flag was seen in front of the Oriental Pearl Tower in Shanghai.
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SINGAPORE – Bond defaults by companies linked to the Chinese state are set to continue into the new year, but analysts say “zombie” units may be a good thing as weeds in the long run.
Investors generally consider government-backed companies “safeguards” as a safe bet that Chinese officials will protect those in trouble. However, in recent weeks a string of lapses – including highly rated entities – have challenged that notion.
Some high-profile State-owned businesses that have recently defaulted in repaying their debts include Minor Yongcheng Coal and Electricity, chipmaker Tsinghua Unigroup and Huachen Automotive Group.
Analysts at CreditSights, a research firm, wrote in Monday’s report, “Market participants are once again reminded that not all state-owned enterprises (SOEs) are made equal; some less similar than others Huh.”
“As the flaws of the default have shown, the assistance provided by state ownership is more granular and the Chinese government at rest is more tolerant of defaults,” he said. “SOEs that are not in strategically important industries or have deviated from their core businesses cannot be saved by the state.”
Yongcheng Coal & Electricity’s default shocked many investors given its AAA-rating by a domestic agency. But the company is “a typical example of a big risky company” that was flagged off by China’s central bank earlier this month.
The People’s Bank of China warned in its Financial Stability Report – a translation of the Mandarin-language text according to CNBC – that the following problems in some large companies could pose a risk to the entire economy:
- Aggressive expansion into various industries and sectors that accumulate more debt than the repayment capabilities of companies.
- Corporate governance issues such as complex series of borrowing, hidden inter-group transactions and mis-disclosures within a group of companies.
- Reliance on lending to repay debt.
“These problems are relevant” for Yongcheng Coal and Electricity, Jefferies analysts said in a report Thursday.
Although the omission of large state-owned companies harms Sentiment in the short term, some of these “zombie” firms will benefit banks and investors in the long run. Weeding, for banks He said that problematic companies allow them to quickly identify risks and choose “quality” collateral for those risks.
Overall, some insolvency and default are “part of a healthy, functioning market, as long as widespread contagion is avoided and the process has a relatively controlled trajectory,” CreditSights said.
The research firm reported that allowing “incompatible entities” to go under resources, renewables in China, would promote “greater economic mobility” in nutrition, and reduce the specter of “zombie” SOE.
More defaults come
Following a recent lapse, Chinese officials have reportedly vowed “zero tolerance” for malpractice among bond issuers. Regulators have launched investigations into Yongcheng Coal & Electricity and Huchen Automotive Group, as well as their bond underwriter, reported to Reuters.
It won’t hold more Defaults between state firms.
“This is not the first time that onshore defaults have given rise to concerns and it will not be final – ultimately we believe China has the ability to throw the market back into the water to calm political will and policy,” credits said.
Rating agency Fitch said in a report last week that the number of SOE defaults could “moderately increase” in 2021 due to the possibility of a strengthening of funding conditions in China.
The agency said, “China’s central bank has moved towards a more neutral policy stance, recovering economic growth from the effects of the coronovirus epidemic, and we expect funding conditions to improve in 2021 compared to 2020.” “
It states that vulnerable areas with overpopulation or occupational areas face high default risk due to low probability of receiving state support.
Fitch said that but the average default risk of SOEs is lower than that of private companies. The agency reported that 20 private firms defaulted on their onshore bonds From January to October this year, compared to five state companies doing so in the same period.
– CNBC’s Weizen Tan contributed to this report.