China Insight: No Slowdown in Credit Clean-up in 2020

China’s corporate bond sector ended the year 2019 with heightened concerns about defaults. With the bond exchange and tender offers by the Tewoo Group in December marking the first time a Chinese state-owned enterprise has defaulted on its USD bonds in 20 years, we are afraid that China corporate bond defaults will continue to stay elevated in 2020, no better than what we saw over the past two years.

We're not surprised by an intensification of credit defaults in 2018 and 2019 given the fact that many private enterprises rushed to issue onshore bonds with a maturity of 2-3 years back in 2016. However, we also attribute the sharp increase in credit defaults over the past two years to China policymakers' intention to prioritize credit clean-up. Simply speaking, the policymakers just let defaults occur as they wanted to see over-levered corporate entities fail and restructure their indebtedness. We don't think the policymakers' attitude will change significantly in 2020. As such, there is a good chance that onshore private enterprises will continue to see their credit spreads staying wide over the next few quarters (chart 1).

Data suggests that the financial outlook balance sheet outlook of private enterprises did not improve in Q3 2019. Specifically, revenue, net profit, and cash inflows (chart 2) were still under pressure. The net financing via corporate bond issuance decreased notably in 2019 (chart 3), in contrast to 2018. By industry, the net debt financing dropped significantly in real estate, industrials, materials and consumer discretionary (chart 4).

In our view, whether those under severe financial stress can see the light at the end of tunnel will largely be subject to an availability of external support. Beijing Oriental Landscape and Shandong Ruyi Technology Group set a good example telling how important an entry of state-owned enterprise (SOE) as a shareholder and/or guarantee provider was in a rescue of distressed private enterprises.

However, needless to say, whether or not an SOE rescue can be obtained to a large extent is dependent on the importance of the private enterprise concerned to the economy and/or the value of the technologies it owns.

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