Debt default to rise amid China's deleveraging drive
Chinese corporate bond default amount hit a record high of RMB 115.45 billion (HK$135.49 billion) in 2018, while corporate bond default cases more than tripled to 119. The high leverage ratio of Chinese firms has led to an unprecedented wave of corporate bond defaults in China, experts said.
Corporate financing becomes difficult in deleverage environment
Fung Don Hau, a former senior manager of Hong Kong monetary authority, said that the total debt to GDP ratio in China is 300%, which is two times higher than the generally accepted standard of the world. “The figure is relatively high, which means China has to repay 3 dollars of debt for every dollar they make. ” When the financial market gets worse, it is easy for the Chinese market to crash. Therefore the government has no way but to deleverage the debt ratio of the market.
Due to the deleverage policy, some major banks began to recover their previous bond investments in enterprises. When the previous bonds expired, the banks chose to get back the funds instead of continuing to buy bonds. As a result, companies have to find new creditors to fix their fragile capital chain.
Using high-interest rates to attract customers has become a common means for most medium-sized companies raising funds. “To reach an investment level, a company must attain at least an AA rating. It is relatively hard for most of the companies especially those medium to small-sized firms to achieve that,” Fung said. The high-interest bonds increased the financing costs of enterprises and have a further impact on future bond redemption. Data collected by Thomson Reuters shows the credit spreads widened between China's national debt and the interest rate of AA-rated bonds rose sharply in 2018, implying investors distrust the Chinese bond market.
Restricted market hinders foreign investments
The limited number of foreign investors in the Chinese bond market may also lead to a shortage of funding. Before entering the Chinese bond market, foreign investors need to be authenticated as ‘Qualified Foreign Institutional Investor (QFII)’, a program allows specified licensed international investors to participate in mainland China’s stock exchanges. Also, the investment quota is set to limit their investment amount. “These two regulations make it hard for the foreign investor to enter,” said Fung.
According to the data published by the People’s Bank of China in 2018, commercial banks, which are the largest clients of the local bond market, accounted for 71% of market share. While foreign investors only had 2% of the market.
Expert: Real estate debts could become potential defaults in 2019
Many companies previously borrowed debts during a policy-relaxed environment and these debts were not used for companies' development of the industry, but to speculate on real estate and stocks to earn “quick money”. Fung indicated the practice has fuelled an economic bubble in the real estate and stock markets. In a deleveraging environment, many firms sell their assets, which usually were the real estate and stocks that previously bought by borrowing money, to repay their bonds. This practice may lead to an increase in the supply of real estate while a fall in house prices.
The real estate industry has a higher quick ratio than other industries which indicated potential investment risk. “When the real estate and stock bubbles burst, the relevant companies are having profit problems, so their bond default risk will be relatively higher,” said Zhang Xu, the chief fixed-receiving analyst of Everbright Securities.
For replenishing their capital, many firms sold their lands at a relatively low price. Hong Kong International Construction Investment, a subsidiary of Hainan Airlines, announced that it would be sold the last land in Hong Kong at HK$3.9 billion, with a loss of HK$740 million in the transaction.
Mainland fund may be withdrawn from Hong Kong
The default risk in the mainland bond market may lead to a partial withdrawal of mainland funds from Hong Kong. The Hong Kong investment market is highly open to the outside world. When the mainland bond market has a redemption crisis, some mainland funds which are active in the Hong Kong market may return to the mainland. “The prices of real estate, stocks, and bonds invested by these funds may have a larger chance to fall.” Zhang Xu added.
《The Young Financial Post 新報人財經》
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