Arguably, China has spent the better part of a half decade playing Whac-A-Mole with systemic risk.
The fact that nothing has gone horribly wrong is a testament to Beijing’s adeptness when it comes to juggling competing policy priorities. One particularly precarious tightrope act involves a systematic effort to squeeze leverage from a notoriously opaque shadow banking complex plagued by duration mismatch and “mind-boggling cross-holdings”, as SocGen aptly described the situation in 2017.
That deleveraging push came with considerable risk. It was (and still is) impossible to determine where all the credit extended via a dizzying array of off-balance sheet lending channels ended up, so untangling the Christmas lights risks triggering unwinds in unexpected places. Relatedly, figuring out how to root out “unproductive” leverage without accidentally choking off credit to the real economy has proven to be a daunting task indeed.
The deleveraging push has played out alongside an effort to transform the smokestack economy into a more sustainable model built around services and domestic consumption. And then there’s the plan to internationalize the yuan and open up China’s financial markets amid lingering concerns about the heavy-handedness of the state.
The story of defaults in China’s $13 trillion bond market contains elements from all of the larger narratives mentioned above. Last year saw a record number (more than three dozen) new defaults and as Bloomberg wrote on Wednesday, 2019 is on pace to top 2018, at least in terms of the value of defaulted bonds, which stands at 40 billion yuan so far.
Earlier this week, China announced targeted RRR cuts for mid- and small-sized banks in an apparent bid to boost lending to local economies. The move was the latest in a string of efforts to keep credit flowing to the private sector. As Bloomberg wrote Wednesday in a neat little piece which tells the story of five companies that have defaulted in 2019, “2016 was more a story of China’s push to shrink excess industrial capacity having reverberating effects in credit markets”, while what we’ve seen since then is in no small part attributable to the deleveraging push.
To be sure, this is a topic we’ve been over before, most recently in February when the China Minsheng Investment drama was in the news.
But amid the improvement in China’s activity data (which looks like it may prove fleeting) and considering this week’s targeted RRR cut and ongoing questions about how China’s credit impulse will evolve following volatile reads on TSF and new yuan loans in the fist quarter (here, here and here), it’s worth a quick update on where things stand in terms of defaults.
As noted above, 2019 is set to top 2018 when it comes to the amount of defaulted bonds. As far as the number of defaults goes, Goldman notes that “there have been 12 new domestic bond defaults this year, which is at a similar pace compared to last year when we saw a record 38 new defaults.”
(Goldman)
Although the default rate is just 0.2% (as a percentage of all outstanding onshore corporate bonds), everyone knows that likely understates the case.
“There have been a number of situations where companies failed to meet scheduled bond payments, but were able to repay the amounts in full within the grace period to avert a default”, Goldman reminds you, adding that “there are also occasions where companies managed to secure bondholder agreement to extend payment dates.” Here is a table that lists some companies which fall into the latter category:
(Goldman)
According to the bank, this is no time to get complacent on default risk in China. It’s true that the data inflected in March, but PMIs for April suggest the recovery is fragile and while the latest trade data showed a surprising jump in imports, an unexpectedly lackluster exports print underscored risks to external demand. Renewed trade tensions don’t help.
Goldman also reminds you (and you don’t need this reminder if you remember April 22’s slide in Mainland shares) that “the term ‘structural deleveraging’ was mentioned again in the recent Politburo meeting, suggesting tackling debt issues of SOEs and local governments continues to be in focus.”
Fears that a stabilizing economy will prompt Beijing to dial back stimulus have haunted markets for the past two months, and while Goldman says the “policy put” likely remains squarely in play should things get too dicey, credit risk in China should not be dismissed.
Given that the pace of defaults so far in 2019 is, at best, on par with 2018 and, at worst, suggestive that this year will mark a new record, saying that complacency is not the right approach may seem like an understatement in hindsight.
Finally, for reference, here’s a list of onshore defaults dating back to 2014:
(Goldman)
