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China Defaults: What To Expect When

Trialed in 1986, expanded in 1991, and updated in 2006, China's Enterprise Bankruptcy Law has only this year become important to international investors. The trigger: precedents set by landmark defaults involving U.S. dollar bonds, and growing recognition in the country that court action may be preferable to out-of-court negotiations that drag on for years.

S&P Global Ratings sees these cases as positive for China's credit markets. They raise transparency, facilitate resolutions, and make outcomes more predictable. We anticipate more such cases as defaults rise in China.

The highest-profile debt events this year shed light on what to expect on Chinese defaults. They establish a key template for debt workouts as China improves its restructuring, resolution, and recovery regimes. International investors will find these changes encouraging as more enter the country's bond market, the world's second largest with about US$15 trillion outstanding.

Why Post-Default Events Vary Widely

China's debt market is huge, but international investors only hold some 2.4% of the country's onshore bonds. This low participation, despite the opening of Bond Connect three years ago to encourage foreign buying, is partly due to high uncertainty and poor outcomes in default cases. The recovery process is slow and unpredictable. Transparency on debt resolutions would give international investors more confidence to enter this market.

Chinese defaults have had widely varying outcomes. This is not because the legal framework lacks specificity. Rather, creditors and officials have pushed for different options, often seeing bankruptcy courts as a last resort.

In our view, this is due to the limited experience of lenders and investors, given the short history of China's bankruptcy law and of defaults in the country's bond market, which saw its first case only five years ago.

Fear of a low recovery is also a likely cause, given courts that administer liquidations are not required to maximize the sale price of the assets to be liquidated. This motivates creditors to seek out-of-court settlements that they believe will provide a higher recovery.

Chart 1

image

Differences Arise Between State-Owned And Privately Owned Entities

State-owned enterprises (SOEs) appear to be adopting more structured debt workouts than privately owned enterprises (POEs).

This could be due to the example set by Peking University Founder Group Co. Ltd. (PUFG), China's biggest SOE defaulter. Investors are following the case closely, due to its ownership by China's oldest university and the direct involvement of central authorities (see "Landmark China Default Tests Two Popular Bond Structures," published Sept. 18, 2020, on RatingsDirect).

The People's Bank of China and the Ministry of Education are leading the restructuring. Investors believe the PUFG case will set a standard for legal claims on state-owned issuers after a default.

Just months after PUFG entered court-administered restructuring in February 2020, court actions emerged for other high-profile SOE cases, including Qinghai Provincial Investment Group Co. Ltd. (QPIG) and Tewoo Group Co. Ltd. (see table 1 in the Appendix).

By contrast, well-known POE cases such as China Minsheng Investment Group (CMIG) and Wintime Energy Co. Ltd. and its subsidiary Huachen Energy Co. Ltd. have seen little legal progress following their defaults two years ago (see table 2).

Mixed Messages Create Confusion

Defaults in China are typically--but not always--preceded by news of financial or operational distress. As many companies do not comment on such news, the situation can confuse investors, especially if positive developments are mixed in with negative headlines.

For example, PUFG issued a Chinese renminbi (RMB) 1.55 billion bond, then defaulted less than two months later. QPIG repaid a US$300 million bond in each of the two quarters prior to its default. Such actions may have assured investors, but the signals were ultimately misleading.

Wavering government support, typically in the absence of official statements, adds to the confusion for distressed SOEs. Reports that the state may step in with support might be denied soon after, as was the case for QPIG months before it defaulted.

Ambiguous Reporting Precedes Decisive Defaults

China has limited experience with bond defaults, which are often not reported as such in the media.

International investors view a failure to pay interest or principal on time and in full, or a distressed bond exchange, as a default. However, reporters in China often call these events delayed or partial payments, or agreements to defer or reduce payments.

The language is ambiguous, but the defaults that follow are not. For example, media reports on Tewoo noted discussions with creditors to "convert" short-term debt (below one year) to something longer term. Three months later, the entity simply defaulted.

Chart 2

image

Asset Freezes Signal Start of Legal Actions

After the first default event, creditors often apply to local courts to freeze the assets of the debtor.

In Wintime's case, the court froze assets a day after the first default event, while PUFG took four days, and CMIG took a month. These actions were meant to secure the collateral underlying the debt, and they signaled the start of legal actions.

Delayed Payments Are Not A Path To Resolution

Defaulted companies in China sometimes make partial payments on interest or principal after a default. This may happen a few days (in the case of QPIG), a few months (CMIG), or a year (Wintime) after the initial default (see table 2).

While this reflects a willingness to pay, the issuer's inability to pay soon catches up with it. In no case have we seen issuers fully repay bondholders in this way without an organized legal or out-of-court process to restructure the defaulted bond. We see these payments as moderately positive, but not indicative of a path to resolution.

From a rating perspective, any reduced or delayed payments beyond those allowed by the terms of the bond, such as any grace period, constitutes a default.

Creditors' Meetings First Step In Engagement

The first out-of-court creditor or bondholder meetings are typically held within three weeks to three months of the first default event. In cases of extended inaction by stakeholders, such as QPIG, it may take a year or more for the first meeting to occur (see table 2).

These meetings are the first steps in engaging creditors to reach resolution. The meetings may be held to give notice to investors of an issuer's inability to pay, or to seek agreement to extend the date or reduce the amount of upcoming interest or principal payments (see the examples of PUFG and CMIG in tables 1 and 3).

It is important to monitor the developments of all creditor meetings. In out-of-court processes, the two creditor groups--bank lenders and bondholders--typically meet separately and do not coordinate demands. As the two groups' interests may not be aligned, outcomes for one may be negative for the other.

Distressed Tenders Equivalent To Default

An important development is distressed SOEs' increased use of tender offers, or offers to buy back outstanding bonds at discounted prices to reduce their debt burdens. Such offers are typically made months before the first default event, but sometimes months after (Tewoo). In extreme cases, the tender offer may come up to a year after the default (QPIG).

Tender offers after defaults tend to be at steep discounts that reflect the bonds' traded prices rather than the issuers' ability to pay. Tewoo's tender prices ranged from 30-60 cents on the dollar; QPIG offered 30-40 cents. The offers were largely in line with the traded levels of their bonds at that time (see table 1).

Such tenders are typically bad for investors. After a default, issuer transparency and bond liquidity are often low to nil. This may translate into punishing discounts on the bonds' traded price. The issuer's ability to repay the bonds may be substantially better than what the bond price indicates, as a result.

When an issuer is in distress, we see tenders or other forms of payment delays or reductions outside the terms of bonds to be equivalent to defaults. This is irrespective of creditors' willingness to accept the tender terms. The event constitutes a default even if an issuer has not defaulted outright on interest or principal due (see "Rating Implications Of Exchange Offers And Similar Restructurings," published May 12, 2009).

More Cases Will Bring Better Practices

We believe the need for resolution, particularly in the state sector, will motivate issuers and investors to adopt in-court processes laid out by the bankruptcy law.

As such cases cumulate, better practices are likely to emerge in China's domestic and international bond markets. SOEs are increasingly choosing the structured in-court approach, and we anticipate more POEs to follow.

This will provide more predictability in resolutions, and is clearly good for investors at home and abroad. To the extent it builds confidence and stimulates liquidity for China's bond markets, it will be good for issuers too.

Appendix

Table 1

Key Events Before And After Default For State-Owned Enterprises--Select Cases In 2020
Date Days Key events
Peking University Founder Group Co. Ltd. (PUFG)
Oct. 10, 2019 (53) Issued: RMB1.55 billion two-year domestic bonds at 6.5%
Dec. 2, 2019 0 Default: failed to repay RMB2 billion onshore commercial paper due Dec. 2, 2019 (RMB19s)
Dec. 6, 2019 4 Freeze: court froze shareholdings in two key subsidiaries
Dec. 20, 2019 18 Meeting: with holders of RMB19s, agreed to extend to Feb. 21, 2020
Dec. 26, 2019 24 Freeze: by court on more shares in two key subsidiaries
Feb. 14, 2020 74 Petition: lender Bank of Beijing Co. Ltd. filed reorganization petition to Beijing court
Feb. 19, 2020 79 Petition: accepted by court.
Feb. 19, 2020 79 Administrator: appointed by court, includes PBOC, Ministry of Education, other regulators
Feb. 21, 2020 81 Default: failed to repay RMB19s and coupon of US$310 million FRNs, triggered cross-default
Feb. 21, 2020 81 Claims: called for creditors of the group to file claims to the administrators
Feb. 21, 2020 81 Suspension: trading of U.S. dollar bonds suspended on HKEX from Feb. 21, 2020
Apr. 14, 2020 134 Default: PUFG said it was not able to pay any interest or principal on debt due to restructuring
Apr. 20, 2020 140 Investors: administrators began soliciting strategic investor to join the restructuring
Apr. 21, 2020 141 Claims: deadline for creditors to file claims to the administrators
Apr. 30, 2020 150 Meeting: of bondholders held for the first time
July 31, 2020 242 Restructure: four key subsidiaries lined up for merging
Aug. 3, 2020 245 Claims: calls for creditors of key subsidiaries to file claims to the administrators
Aug. 19, 2020 261 Claims: administrators rejected claims of keepwell bonds on onshore group parent
Qinghai Provincial Investment Group Co. Ltd. (QPIG)
Sep. 14, 2018 (161) No support: Qinghai government denied press reports it would take over QPIG
Sep. 26, 2018 (149) Payment: repaid its US$300 million bonds due Sept. 26, 2018
Dec. 11, 2018 (73) Payment: repaid its US$300 million bonds due Dec. 11, 2018
Feb. 22, 2019 0 Default: on coupon of US$300 million bond due Feb. 22, 2020 (USD20s), paid on Feb. 28, 2020
Feb. 24, 2019 2 Late payment: failed to pay RMB21 million bonds due Feb. 24, 2019, paid on Feb. 25, 2019
Mar. 6, 2019 12 Cross-default: said late payment of USD20s coupon triggered cross-default
Aug. 22, 2019 181 Default: on coupon of USD20s due Aug. 22, 2019, paid on Aug. 29, 2019
Sep. 4, 2019 194 Suspension: requested trading suspension of its bonds on HKEX
Jan. 10, 2020 322 Default: on coupon of US$300m bonds due July 10, 2021, triggering cross-default
Jan. 13, 2020 325 Meeting: with bondholders, QPIG said it could not pay USD 7/21s' coupon
Feb. 5, 2020 348 Tender: offer for USD20s at 41.19, USD 7/21s and US$250 million bond due March 22, 2021 at 36.7
Feb. 7, 2020 350 Meeting: with bondholders on tender offer, which ended abruptly amid complaints, according to press reports
Feb. 19, 2020 362 Tender: accepted by 56% of 20s holders, 33% of 3/21s, 69% of 7/21s
Feb. 21, 2020 364 Default: QPIG said it could not repay USD20s on Feb. 22, 2020, triggering cross-default
Mar. 22, 2020 394 Default: on coupon of USD 3/21s, triggering cross-default
June 19, 2020 483 Petition: Xining Intermediate People's Court accepted reorganization petition
July 10, 2020 504 Investors: administrators began soliciting strategic investors to join the restructuring
Aug. 28, 2020 553 Committee: of creditors met for first time to vote on asset sales
Tewoo Group Co. Ltd. (Tewoo)
Apr. 3, 2019 (113) Extension: met with major lenders to extend short-term (below one year) loans
July 1, 2019 (24) Default: a subsidiary failed to pay interest due June 21, 2019 on a bond
July 6, 2019 (19) Committee: set up committee of creditors, local media reported
July 25, 2019 0 Default: on coupon of a bond (18 Haotong 01) issued by a subsidiary.
Oct. 21, 2019 88 Claims: creditor committee asked financial institutions to file their debt claims
Nov. 19, 2019 117 SBLC: coupon on 3.15% bonds due Dec. 1, 2020 (SBLC 20s) paid by SBLC provider ICBC
Nov. 22, 2019 120 Tender: offer to buy back 19s/20s/22s/perpetuals at 67/57/53/36, or exchange for 24s/26s/29s/39s
Dec. 11, 2019 139 Tender: results show of US$1.25 billion bonds offered, 57% tendered, 27% exchanged
June 1, 2020 312 SBLC: 20s coupon paid by SBLC provider ICBC
July 31, 2020 372 Court: Tianjin People's High Court accepted reorganization petition filed by onshore creditors
Aug. 5, 2020 377 Court: appointed liquidation committee as administrator, called the first creditor meeting
Oct. 12, 2020 445 Meeting: of creditors held for the first time
Sep. 16, 2020 419 SBLC: trustee of SBLC 20s demanded repayment by SBLC provider ICBC
Sep. 24, 2020 427 SBLC: provider ICBC repaid SBLC 20s in full
Note: Numbers in parenthesis mark number of days before default. RMB--Chinese renminbi. PBOC--People's Bank of China. SBLC--Standby letter of credit. FRN--Floating-rate note. HKEX--Hong Kong Exchanges and Clearing Ltd. ICBC--Industrial and Commercial Bank of China Ltd. Sources: Company filings, reports, media releases, S&P Global Ratings.

Table 2

Key Events After Default For Select State-Owned And Privately Owned Enterprises
First default date Court asset freeze Late bond payment First creditor meeting First bondholder meeting Offer to extend or tender bond Court accepts reorganization petition Debt claim to court First court creditor meeting Court accepts or rejects claim
PUFG Dec. 2, 2019 4 18 18 79 81 150 261
QPIG Feb. 22, 2019 2 325 348 483 553
Tewoo July 25, 2019 88 120 372 445
CMIG Jan. 29, 2019 31 170 57 175
Wintime July 5, 2018 1 49 12 263 813 813 866 866
PUFG--Peking University Founder Group Co. Ltd. QPIG--Qinghai Provincial Investment Group Co. Ltd. Tewoo--Tewoo Group Co. Ltd. CMIG--China Minsheng Investment Group. Wintime--Wintime Energy Co. Ltd. Sources: Company filings, reports, media releases, S&P Global Ratings.

Table 3

Key Events Before And After Default For Privately Owned Enterprises--Select Cases In 2020
Date Days Key events
China Minsheng Investment Group (CMIG)
Jan. 29, 2019 0 Default: failed to repay RMB3 billion 5.2% bonds due 1/29/19 (RMB19s)
Feb. 14, 2019 16 Suspension: issuer requested trading suspension of its U.S. dollar bonds on HKEX
March 1, 2019 31 Freeze: court froze RMB15 billion of assets between March 2019 and April 2019
March 27, 2019 57 Committee: of creditors chaired by Chexim formed to overseas asset disposals
April 8, 2019 69 Default: (a) failed to pay RMB904 million on bond due April 8, 2019, extended to April 19, 2019
April 16, 2019 77 Warning: CMIG said may be unable to pay RMB1.57 billion bond due April 21, 2019
April 18, 2019 79 Default: (b) Postal Savings Bank and Bank of Dalian demanded immediate payment of loans
April 18, 2019 79 Cross-default: triggered by (a) and (b) on US$500 million bonds due Aug. 2, 2019 (USD19s)
June 13, 2019 135 SBLC: trustee of US$300 million 3.25% SBLC bonds due 2020 (USD20s) demanded repayment
June 14, 2019 136 SBLC: trustee demanded repayment by USD20s' SBLC provider, CCB
June 18, 2019 140 SBLC: provider CCB repaid USD20s in full
July 18, 2019 170 Default: only partially repaid its RMB1.46 billion 6.5% commercial paper
July 23, 2019 175 Extension: solicited from bondholders to extend USD19s due date to Aug. 2, 2020
Aug. 22, 2019 205 Meeting: of bondholders agreed to extend USD19s due date to Aug. 2, 2020
Aug. 26, 2019 209 Default: partially paid RMB800 million bond due Aug. 26, 2019, paid the rest on Aug. 29, 2019
July 24, 2020 542 Extension: solicited from bondholders to extend USD19s due date to Aug. 2, 2021
Sept. 10, 2020 590 Meeting: of bondholders, who agreed to extend USD19s due date to Aug. 2, 2021
Wintime Energy Co. Ltd. (Wintime)
July 5, 2018 0 Default: on a loan and a RMB1.5 billion bond, triggered cross-default on 14 onshore bonds
July 6, 2018 1 Freeze: Wintime said its holding of 32% stake in Wintime Energy Co. Ltd. was frozen
July 17, 2018 12 Meetings: held with holders of 15 defaulted onshore bonds every one to two months
Aug. 23, 2018 49 Committee: of creditors set up, included CBIRC, PBOC, CSRC, 70-plus financial institutions, and representatives from the Shanxi, Henan, and Suzhou governments
Aug. 23, 2018 49 Investor: signed strategic agreement with Beijing Energy Holding Co. Ltd. (BEHC) on investment, asset injection, and reorganization
Nov. 7, 2018 125 Default: Huachen Energy Co. Ltd., a subsidiary with a U.S. dollar bond outstanding, defaulted on a RMB48 million loan
Nov. 30, 2018 148 Investor: Wintime said BEHC completed due diligence and was developing a reorganization plan
25-Mar-19 263 Restructure: payment plan agreed with holders of a RMB bond, two more were later restructured
June 17, 2019 347 Late payment: Huachen paid the coupon on its US$500m bond due 2020 (US$20s) a month late
July 19, 2019 379 Committee: of creditors held a meeting and agreed to the preliminary restructuring plan
Aug. 15, 2019 406 Investor: strategic agreement with BEHC, valid for one year, expired with no investment
Nov. 18, 2019 501 Default: Huachen failed to pay USD20s' coupon, did not pay later within the grace period
Dec. 7, 2019 520 Default: Huachen failed to pay the principal and coupon of an onshore bond
Jan. 2, 2020 546 Committee: Had another meeting and made some improvement on the restructuring plan
Jan. 22, 2020 566 Acceleration: holders of more than 25% of the USD20s demanded immediate payment
Apr. 21, 2020 656 Restructure: Huachen appointed PWC as restructuring adviser on the USD20s
Aug. 6, 2020 763 Court: a creditor filed a reorganization petition to the court in Jinzhong, Shanxi Province
Sept. 25, 2020 813 Court: the reorganization petition was accepted by the court
Sept. 25, 2020 813 Claims: called for creditors of the group to file claims to the administrators
Nov. 17, 2020 866 Meeting: of creditors held for the first time.
RMB--Chinese renminbi. SBLC--Standby letter of credit. Chexim--The Export–Import Bank of China. USD—U.S. dollar. CCB--China Construction Bank Corp. HKEX--Hong Kong Exchanges and Clearing Ltd. ICBC--Industrial and Commercial Bank of China Ltd. CBIRC--China Banking and Insurance Regulatory Commission. PBOC--People's Bank of China. CSRC--China Securities Regulatory Commission. PWC--PricewaterhouseCoopers. Sources: Company filings, reports, media releases, S&P Global Ratings.

Table 4

Key Events Under The China Enterprise Bankruptcy Law
Legal action Days Description
Filing 0 Creditors submit a reorganization petition on the filing date (Filing)
Confirmation 5 Court to confirm receipt of the petition (Confirmation) within five days of Filing
Objection 12 Opposition to the petition by any creditor to be filed within seven days of Confirmation
Decision 15 Within 15 days of Filing, court to decide (Decision) to accept (Acceptance) or reject (Rejection)
Administrator 15 Court to appoint an administrator upon Acceptance of the petition
Acceptance 30 Court can extend the period for making the Decision by 15 days, given approval by a higher court
Administrator 30 Court to serve notice to creditors (Notice) within five days of reaching the Decision
Objection 45 Objection to the Rejection to be appealed to a higher court within 10 days of receiving the Notice
Reporting 50 Debtor to report to the court its assets and liabilities within 15 days of the Notice
Claims 120 Court to set debt claims filing deadine, to be within 30 days to three months of Acceptance
Plan 210 Debtor/administrator to file reorganization plan (Plan) to the court within six months of Acceptance
Extension 300 Court may extend the Plan filing deadline by three more months after the six-month limit
Meeting 330 Court to call a creditors' meeting (Meeting) within 30 days on receiving the Plan
Approval 360 Administrator can ask the court to approve the Plan in 30 days if it's not approved at the Meeting
Insolvency 360 If the court does not approve the Plan, it can terminate the case and declare the debtor insolvent
Notice 370 Court to notify debtor within five days, and creditors within 10 days, of declaring insolvency
Liquidate 550 Administrator to "quickly" plan "timely" liquidation, which may mean six months from notice of Insolvency
Sources: China Enterprise Bankruptcy Law, S&P Global Ratings.

Related Research

This report does not constitute a rating action.

China Country Lead:Charles Chang, China Country Lead, Hong Kong + 852-2912-3028;
charles.chang@spglobal.com
Secondary Contacts:Boyang Gao, Beijing + 86 (010) 65692725;
boyang.gao@spglobal.com
Chang Li, Beijing + 86 10 6569 2705;
chang.li@spglobal.com

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