C.HINAS CREDIT EVALUATION Agencies do not hide their love for the state. The state pedigree of Yongcheng Coal and Electricity was high on the list of merits in a recent credit check CCXI, one such agency, who on October 10th expressed their confidence in the group with a first class expression AAA 1 billion yuan ($ 152 million) bond rating.
Yongcheng’s default on another 1 billion yuan bond a month later triggered a shock wave across China’s $ 14 billion bond market. The company paid interest overdue three days later, but not before investors dumped government-secured debt with ties to Henan Province, the region in central China in which it is based. The shocking news that a state group with a recently AAAThe rating was down and halted scheduled debt issuance of at least 20 billion yuan worth of debt the following week as government debt yields rose.
The concern was so great that a large state-owned company in neighboring Shanxi Province was forced to issue a rare statement to investors on November 14th promising that the companies it controlled would not default. “What was special about this case was that it was completely unexpected,” said Charles Chang from S.&P., another rating agency.
Investor panic has focused on Yongcheng, but there are signs of greater turmoil. Huachen Automotive, an automaker owned by a provincial government in the north, announced Nov. 16 that it had requested a restructuring after a bond defaulted in October. Tsinghua Unigroup, a technology company controlled by Tsinghua University, failed to repay a 1.3 billion yuan bond on the same day. The companies enjoyed it AAA and AA Reviews each.
It is no surprise that state-owned companies can default. Yongcheng is one of ten to have done so this year. Regulators have realized that they can no longer afford to rescue inefficient, loss-making businesses. A small but steady stream of weak state-owned companies has been allowed to go down since 2015, as part of a government plan to impose discipline on the market. Default values also make it possible to better assess risk, which is difficult for foreign investors to do. As defaults have risen over the past three years, foreign investors have plowed record amounts of money into the Chinese bond market.
But Yongcheng’s default has alarmed investors by knocking out the old rulebook that was used to determine which groups could get government support and which could go broke. Parent companies were the strongest guiding light so far. For example, Yongcheng’s parent company is one of Henan’s largest state-owned groups and is wholly owned by the province’s wealth manager, making Yongcheng a state royalty in the region. Huachen Automotive belongs to a similar unit. This proximity to powerful asset managers gave investors confidence that the state would rush to the rescue at the first sign of distress. No longer.
Scaling was also important in the past. Large government groups have been valuable to cities and provinces because they provide secure jobs for tens of thousands of people. Huachen Automotive alone employs more than 40,000 people. Restructuring would put jobs and social stability at risk, but these are risks that the government seems increasingly willing to take. “Parent company, size – that’s why people argue you should buy,” says Edmund Goh of Aberdeen Standard Investments, a wealth manager. “That is starting to change and people will read more details.”
Investors and rating agencies need to study the fundamentals of state-owned corporations rather than relying on perceived government support. S.&P. expects more failures from large state groups that were once considered inviolable. Zhu Ning, a professor at the Shanghai Advanced Institute of Finance, said regulators may even “take action against the rating agencies for better-informed ratings.” The shift will affect local agencies such as CCXIwho are under pressure from state groups to distribute as many sparkling ones as possible AAA Reviews as possible. ■
This article appeared in the Finance & Economics section of the print edition under the heading “No guarantees”.