Key Takeaways
- Central authorities appear to be concerned about the impact of SOE defaults, in light of recent instructions to local governments to mitigate such risks.
- This may not calm investor nerves because defaults will likely continue to rise due to refinancing pressure.
- In our view, debt restructurings will be encouraged for SOEs with no prospect of a turnaround.
A surprise default by a Chinese state-owned enterprise (SOE) is still reverberating in domestic financial markets, nearly six months later. S&P Global Ratings believes Beijing is trying to mitigate the market impact from such events.
Last month, the State-Owned Assets Supervision and Administration Commission of The State Council (Central SASAC) released guidance on strengthening management of local SOEs' debt risk (see Related Research). In our opinion, this document indicates that central authorities want local governments to take a firmer grip. This means more discipline in borrowing habits.
Despite closer monitoring by central authorities, we still expect bond defaults to increase from a low base as China continues to dig out from COVID-19 while transitioning to a consumption-driven economic model.
A Default And Its Reverberations
SASAC's guidance sends a signal that Beijing is concerned about SOE credit events. Since Henan-based Yongcheng Coal and Electricity Holding Group (Yongmei; not rated) defaulted in November last year, Chinese corporates in some regions are finding it difficult to access capital markets.
Bonds usually account for a small part of the local SOEs' debt structures. But their defaults are more likely to give rise to regional financial risks. This is largely due to the numerous investors in securities and the fast information spread. Contagion can easily engulf other local entities and even to other regions. After Yongmei's default, net onshore bond financing become negative in some provinces including Henan, Shanxi, and Yunnan (see chart 1).
Chart 1
The central SASAC guidance puts pressure on local SASACs to better keep track of bond-default risks. The blueprint asks the local SASACs to:
- More closely monitor SOEs' debt structure and maturity profiles;
- Instruct SOEs to develop viable bond repayment plans;
- Guide risky SOEs to negotiate with bondholders before maturity on the debt restructuring when the bonds cannot be paid off.
While our own criteria would classify as defaults most debt restructuring cases (e.g., bond maturity extension without adequate compensation), we believe better workouts can improve funding prospects for weaker regions. Henan SOEs have slowly begun to resume bond issuance, after Yongmei agreed to repay 50% of the defaulted bond's principal value, and extend the maturity of the other 50% (see chart 2).
Chart 2
More Emphasis On Improving Stand-Alone Credit Profiles
While the SASAC guidance indicates Beijing's desire to mitigate the reverberations of SOE defaults, it emphasizes market-based resolutions. Debt restructurings are encouraged for SOEs with no prospect of a turnaround.
The guidance asks local SOEs to improve competitiveness and deleverage substantively, which is the ultimate solution for resolving SOE credit risk. For local SOEs, persistently weakening stand-alone credit profiles (SACPs) will likely signal a diminishing timely support for more commercially minded SOEs (see "China Recovery Could Bring More Defaults," published on RatingsDirect on Nov. 17, 2020). This has been shown by SOEs defaults in recent years.
Given China's high maturity walls (see chart 3), we view refinancing risk as a more imminent issue than leverage. Weaker SOEs' funding channel could be restricted, because the guidance asks for monitoring the bond issuance. The central SASAC called for a control on the proportion of bonds in the debt structure of risky local SOEs. For example, the outstanding bonds are not targeted to exceed 30% of the total interest-bearing debts. Bonds due within one year shall account for no more than 60% of the outstanding bonds.
Chart 3
The guidance also proposes limits on local SOEs' implicit debts; in particular, the issuance of perpetual bonds. Perps are usually treated as equity and not recorded as debt on balance sheet. We believe the policy goal is to reduce the perpetual bonds' outstanding amount and discourage using perpetuals to meet the deleveraging targets.
All of these could restrict the bond issuance by weak SOEs. The share of weak SOEs' bond would further drop, just as the share has dropped for privately owned enterprises following a wave of defaults since 2018. These private borrowers, perceived as riskier and more prone to default, saw their share of onshore bond issuance reduced to 9% at the end of 2020 from 11% by the end of 2018 (see chart 4). Weak SOE issuers have to rely more on bank loans for funding. If financial institutions fail to roll over loans or even reduce credit lines, refinancing risk for weak SOEs is less likely to get mitigated.
Chart 4
Related Research
- Huarong Flags China Transparency And State Support Risks, April 20, 2021
- Asia-Pacific Corporate And Infrastructure Credit Outlook 2021, Feb. 9, 2021
- China Recovery Could Bring More Defaults, Bring More Defaults, Nov. 17, 2020
- China Credit Spotlight: Catching The Mice In Mixed-Ownership Reform, Aug. 13, 2019.
- Chinese readers can view the SASAC guidelines, titled "Guidance on Strengthening Debt Risk Control of Local State-owned Enterprises," by clicking here.
This report does not constitute a rating action.
| China Country Specialist: | Chang Li, Beijing + 86 10 6569 2705; chang.li@spglobal.com |
| Secondary Contact: | Boyang Gao, Beijing + 86 (010) 65692725; boyang.gao@spglobal.com |
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