Tewoo Group Co. Ltd.'s recent U.S. dollar-bond default was China's first instance of debt restructuring by a state-owned entity in two decades and may be the first of many such defaults, S&P Global Ratings predicted in a report published Dec. 12.

"In our view, Tewoo's default is a landmark case, and demonstrates a growing tolerance for defaults by distressed SOEs," S&P Global Ratings credit analyst Cindy Huang said. The Tianjin district-based commodity trader conducted an exchange and tender offer for four dollar bonds which the rating agency considers "tantamount to a default," after which investors were forced to accept a partial repayment on the bonds.

This instance indicates the Tianjin government's readiness to shift to market-led debt restructuring of failing state-owned companies from providing full bailouts, primarily driven by the municipality's weakening economy and large debt burden, the rating agency said.

This waning commitment to support distressed state-owned enterprises has spread to other local governments with weakening financial positions, as shown by the 21 negative rating decisions on such entities S&P Global Ratings has made since 2018. However, the rating agency expects local governments to push for debt restructuring instead of liquidation, of which investors will end up paying the price.

Default tolerance

S&P Global Ratings expects China's central government to be increasingly tolerant of defaults and for bailouts to be more selective. "The Chinese government's deleveraging initiative to mitigate potential large financial risks brought by high debt burden has weakened bailout potential for SOEs over the past few years," the agency said.

Furthermore, Hohhot Economic and Technological Development Area Investment and Development Gr failed to redeem private placement notes, likely making it the first bond default for a local government financing vehicle. This is in sharp contrast to China's traditional mandate that local government's would support local government financing vehicles no matter what, and led S&P Global Ratings to expect more failures or missed repayment of debt by these vehicles.

Similarly, S&P Global Ratings expects corporate onshore bond defaults in China hit a high in 2020, along with offshore bond defaults climbing into 2021.