China credit watch: reassessing default risks of Chinese state-owned firms

A debt restructuring plan proposed by a Chinese state-owned firm that’ll impose deep losses on bondholders has sparked speculation that Beijing may have changed its stance toward bailing out state-owned enterprises.

On November 25, Tewoo Group, a commodity trading company owned by the Tianjin municipal government, unveiled a debt restructuring plan. Its bondholders were offered a difficult choice: suffer losses of up to 64% or accept delayed repayments with reduced coupons on $1.25 billion of dollar bonds.¹

The announcement marks the first de facto default for a Chinese state-owned enterprise (SOE) in the offshore U.S. dollar bond market since 1998.² In our view, this can be traced to three factors:

  1. the company’s weak stand-alone credit profile (due to high leverage levels),
  2. the lack of strategic importance of Tewoo’s commodity trading business to the authorities and/or the broader economy, and
  3. the Tianjin municipal government’s relatively high debt level compared with other tier-one Chinese cities.

Tewoo’s weak stand-alone credit profile means that the company must rely on bailouts from its state backers in order to survive. However, the Tianjin municipal government has limited incentive/capacity to provide support, given the lack of strategic importance of Tewoo’s business to its plans and its own high debt level.

Unsustainably low default rates

In terms of broader implications, the potential for additional defaults in China’s credit markets remains a hot topic among investors. The onshore default rate for Chinese SOE bonds has remained below 0.3% for the past few years despite high leverage levels³; the low default rate within this segment was mainly due to implicit support from the government. Our long-term view is that such levels aren’t sustainable, and the authorities—both central and local governments—will be more selective when providing bailouts for financially troubled SOEs in the future, especially during rough patches of economic growth. As such, it’s important to remember that claims of government ownership don’t imply implicit support. Going forward, we believe that government support will be increasingly selective given the sheer number of SOEs in existence, concerns about associated moral hazard, and the authorities’ increasing tendency to allow troubled or financially unviable companies to fail and impose losses on investors.

Factors underpinning government support for SOEs

When evaluating claims of implicit government support, it’s important to consider whether the business activity of the SOE is strategically important to the economy or if its default will have a systemic impact on the economy or lead to potential contagion. Other factors include the company’s overall financial health and the willingness and ability of the central/provincial/local government to offer assistance. Broadly speaking, we have a preference for SOEs that provide essential/critical services and have a less favorable view of those operating in highly competitive industries; for example, those running commoditized business lines or dealing with financial investments.

In our view, it’s clear from the latest developments with Tewoo that investors can no longer rely solely on implicit government support for Chinese SOE bonds. Any government support will be increasingly selective on a case-by-case basis, and therefore it’s vital for investors to engage in a more robust credit risk assessment process for SOEs in order to develop a more complete picture of underlying risks.

1 Bloomberg, November 25, 2019. 2 Bloomberg, November 26, 2019. 3 Goldman Sachs, as of October 18, 2019.

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Fiona Cheung

Fiona Cheung, 

Head of Credit Research, Asia ex-Japan Fixed Income

Manulife Investment Management

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