Apparently, the market will witness a wave of defaults by Chinese corporates on distressed dollar debt in 2020.
That’s the overall thrust of a Bloomberg article that garnered some attention on Thursday.
According to the piece, around $8.6 billion in offshore bonds that come due next year sport yields of 15% or more. That’s a big chunk of the total outstanding stock of stressed dollar debt.
Why is this a problem (beyond the obvious, that is)?
Well, because despite the intractable trade war exerting a serious drag on the Chinese economy, policymakers in Beijing have been reluctant to countenance a wholesale pivot away from the yearslong deleveraging push aimed at promoting financial stability.
Although China has, of course, delivered round after round of targeted easing, those expecting broad-based, “kitchen-sink” stimulus have generally been disappointed, although this month’s universal RRR cut marked a step in that direction.
Even when Beijing has expressed a clear desire to stimulate activity and support growth, pledges to keep the economy stable have often been accompanied by caveats about not “flooding” the system with liquidity. Meanwhile, a lower tolerance for excess capacity (colloquially, “zombie” capacity) and the attendant willingness to allow defaults, are part and parcel of Beijing’s efforts to at least project an inclination to allow market forces to work their “magic”, even if that means short-term pain for some issuers.
As Bloomberg reminds you in their piece, 2019 has been a big year for onshore defaults.
“So far this year there have been 25 new defaults in the onshore bond market, at a pace that is only moderately slower than the record pace in 2018 despite the rebound in credit growth this year, and we expect the pace of defaults to remain elevated”, Goldman wrote, in a note dated Thursday, adding that the bank sees a “risk of an even faster pace of default if [there’s] an acceleration in the removal of implicit government support”.
As far as the offshore market goes, Bloomberg cites Morgan Stanley in noting that “China’s high-yield dollar-debt issuers tend to have higher default risks than peers abroad” thanks to shorter maturities. Obviously, a 2.5-year average maturity profile exposes them to the vagaries of the cycle. That’s not a great setup in the current macro environment.
Meanwhile, Goldman cautions that although the situation is far from dire (they characterize credit stress in China as a “slow burn”), “we do expect stresses to continue to emerge as policymakers continue to prioritize the credit cleanup, albeit in a different manner to earlier cycles”.
As opposed to the pre-crisis years when non-performing loans were with large commercial banks, that kind of risk is now concentrated in rural and city banks after the four big players became G-SIBs.
“Therefore”, Goldman says, “problem credits are more likely to come from smaller companies that are reliant on funding from the smaller banks, as well as borrowers who have relied on shadow banking for financing, as the growth in shadow banking credits has slowed substantially over the past two years due to more stringent regulations”.
Does that clear it all up for everybody?