2014 Returns: New Default Wave Underway, Soaring Yields, Ratings Agencies Criticized, SOE Investors Flee Credit Market

Several in-depth articles on the growing (albeit still small) default wave in China.

Key points

The defaults to this point are far behind the 2016 pace, but as I discuss below, the more appropriate comparison may be 2014.
Ratings agencies are already facing criticism.
Private investors are bottom fishing, but SOE investors are being "politically correct" aka avoiding risk.
Regulators are blamed for the defaults.
Credit guarantees are causing trouble again.
No consistent pattern as in 2016, when it default was concentrated in industries such as steel and coal.
Even though defaults are limited, spreads are widening and hundreds of issues trade above 9%.
Govt intervention is rightly dismissed at this point, but what's notable is that its mentioned at all given the overall opinion that this isn't as bad as 2016.

Xinhua: 债券违约频发 六大评级机构受牵连遭质疑
Recently, the credit bond market frequently broke the case of default. As of May 31, there have been 20 bond defaults (including guarantee defaults) since the beginning of this year, and the amount of breaches has been around 12.7 billion yuan. Among them, seven new violations were involved, involving 10 defaulting bonds, and the scale of default was about 5.7 billion yuan.

Substantial bond defaults have caused the issuance of certain issuers such as listed company bonds to be difficult. This has led credit rating companies and even the entire industry to fall into dissent, such as joint rating, joint credit information, Peng Yuan credit, China Chengxin International, Dongfang Jincheng, and Shanghai. Institutions such as the New Century Ratings have been questioned in connection with the default of the issuer’s bonds. Many of them have encountered multiple default bonds.

...At present, rating agencies generally believe that the main cause of the default wave of this round of bonds is the difficulty of refinancing under the background of credit contraction, and there is no direct relationship with rating agencies.
Why don't ratings agencies provide "stress test" ratings?

China Daily: Bond default risks rising for corporates
On Thursday, the Ministry of Finance and the National Development and Reform Commission, the nation's top economic regulator, jointly warned Chinese corporates to guard against debt risks, especially those who have borrowed medium to longterm foreign debt.

"Corporates are forbidden to take guarantees from local governments," said a notice published on the NDRC website, an indication that companies should repay borrowed funds and take risks on their own.

The government's warning is aiming in particular to separate corporate debt from local government debt in order to reduce the local governments' contingent liabilities,
according to Daisy Lu, an analyst with Moody's Investor's Service, another global credit ratings agency.
The credit guarantee returns again!
According to incomplete statistics, a total of 8143 bonds to be repaid will be issued in 2018, and the scale of repayment will be approximately 5.75 trillion yuan. From the perspective of repayment type, the maturity scale is about 5.12 trillion yuan, accounting for 88.89%; the principal cash redemption scale is 511.134 billion yuan, accounting for 8.88%; as of May 25, the resale scale is 128.306 billion yuan, accounting for 2.23%. . From the perspective of bond types, the size of short-term financing bills to be repaid is approximately 2.38 trillion yuan, accounting for 41.36%; medium-term bills are approximately 861.83 billion yuan, accounting for 14.98%; asset-backed securities are approximately 702.636 billion yuan, accounting for 12.21%; corporate bonds The scale of corporate bonds to be repaid was 548.979 billion yuan and 537.343 billion yuan respectively, accounting for 9.54% and 9.34% respectively.
Even though defaults are running behind last year's pace, there's already talk of government intervention.

JRJ: 债券、信托违约接连出现 国家层面是否会出手干预
In 2018, it was hard to overemphasize that the financial market used "unconvinced" to describe it. In the past two months, it was believed that everyone was "spoiled" by bond and trust defaults. The majority of investors were also afraid of "thundering." Institutions generally believe that continuous default events are "labor pains" brought by such measures as strong supervision, de-leverage, and risk removal. At present, the fundamentals of the company are not universally deteriorating, and the overall risk is still controllable.

Bonds and trusts continue to default

Not only the bond market, but also the trust market, which has always been regarded as a “just-in-fighted” market, broke out with several incidents of default. According to Wind's incomplete statistics, at least 12 trust products have been delayed or unable to be redeemed since this year . Download A PP to read more in-depth coverage of this article

Not only the bond market, but also the trust market, which has always been regarded as a “just-in-fighted” market, broke out with several incidents of default. According to Wind's incomplete statistics, at least 12 trust products have been delayed or unable to be redeemed since this year.

At the same time, the scale of maturity of bonds and trust products during the year is still at a high level.

On the bond front, Wind's previous statistics showed that the maturity of medium- and low-grade credit bonds in 2018 was 1.917874 trillion yuan, accounting for 33.81% of the total maturity, and in 2017, the ratio was 28.71%.
 Why is there a continuous breach of contract?

Regarding the “default tide” situation in the bond market, CICC believes that this “default tide” is not an accident. Unlike the risk of debt repayment during the deflation period that was exposed in 2016, the current round of debt default accelerated by the end of last year. The tightening of the financing environment, especially after the introduction of the new asset management regulations, the rapid return of non-standard assets of banks brought pressure to the capital chain of local governments and private enterprises.

As for the frequent breaches of trust products, Guohai Securities believes that the supervision of the new asset management regulations and Circular 55 on the trust industry will inevitably lead to the shrinking of the trust scale. The dismantling of shadow banking means that The financing of enterprises that originally depended on the financing of the trust channel was limited, which led to the tight liquidity of the company and pressure on the company's credit risk and credit spreads. This is also the reason for the rapid increase in breach of the trust industry this year.

According to Lianxun Securities, the current leading companies' profitability and financing ability are stronger. Under the tight financing conditions, the ability to resist risks will be relatively stronger. Some small and medium-sized enterprises with weaker profitability may face greater pressure.
Will the government intervene?
So, for the exposure of this round of credit risk, whether it will intervene at the national level?

The answer is that in the short term, this sign cannot be seen. There are three main reasons:

First, with the release of stocks and exchanges completed, deleveraging has achieved remarkable results in the first half, and the second half has entered an anxious period, the policy is now more determined than ever before.

Second, State Council Deputy Prime Minister Liu He’s intentions on the May 15 National CPPCC Thematic Consultation were clear:

To do business is to have the capital - not only rely on a lot of debt empty gloves white wolf;

Borrowing money is a must--you must take responsibility for repayment after you borrow money;

Investment is to take risks - the investment must bear the corresponding credit risk, can not expect others to come to the fore.

Third, the large-scale trade frictions between China and the United States have come to an end. China has secured valuable time. In the coming period, it will expedite the handling of prominent domestic issues without causing systemic risks. Broad currency + structural tight credit, downgrade + increase The policy portfolio of interest will be the main theme of the future, and it will become even more common to break the corporate ambitions of zombies.

Therefore, it is expected that the relatively concentrated exposure of private companies’ credit risk will continue in the future, and even gradually spread to poorly-positioned state-owned enterprises. It is not easy to achieve leverage without difficulty.
As I've said before, China cannot afford to fight a trade war. China's economy is at its most vulnerable because of its prior credit growth. Most nations are similarly at risk, but it won't take as much to send China into a negative feedback loop. Any external macro shock could do it, including something as simple as a 10 percent rally in the U.S. dollar from current levels, which should carry USDCNY past 7.0 and reignite outflow pressure and depreciation expectations.

East Money: 债市困境亟待破局 部分机构“抄底”
 At the turn of the spring and summer of 2018, successive incidents of concentration breaches caused the bond market to remain in a state of tension. The immediate plight of private enterprises is urgently needed to unlock.

Data show that from the transaction status of the bond secondary market on May 24th, the yield of bonds with more than 10% (including 10%) is 334; the yield with yields of more than 9.6% (including 9.6%) has already reached 400.

Professionals believe that from the market point of view, this price has gone beyond the normal reasonable price range, which means that the issuer may lose the possibility of issuing new debt, and it also means that it will lose the ability to refinance. This situation may further exacerbate the market’s fear of credit debt.

At the same time, the “politically correct” orientation of the state-owned investment institutions is obvious, and some organizations have already started “bottom fishing.”
In an interview with the China Business News, regulators said that the supervisory level is committed to multi-layered efforts to ease the current tight market conditions by calling for guidance, clarification, coordination and negotiation, and intends to establish targets for defaulting companies and venture companies. Specialized trading section to cultivate multi-level investment groups. This time, the concentration of breach of contract is a problem of the entire financial system, and in particular, the situation of the private company's own credit is weak. It is not that the bond market supervision can be reversed, and it requires joint efforts of all sectors.
Including the PBoC, which expanded MLF collateral on Friday.
According to the data, on May 24, 2018, for example, bond transactions in the secondary market showed that a considerable number of bond yields were operating at high levels, and most of them were private enterprises, including state-owned enterprises.

There are 334 bonds with yields exceeding 10% (including 10%) and 400 bonds with yields exceeding 9.6% (including 9.6%). Among them, most high-yield bonds are concentrated in the range of 10% to 20%, with a total of 244. In addition, there are 20 bonds with a yield of more than 40% and 70 bonds with a yield of 20% to 40% (excluding 40%).

In the secondary market on May 24, the yield of the 16 god fog debt has reached 136%, and the current valuation is 53 yuan; the Kaidi debt yield is between 15% and 18%. The risk of breach of contractual shield security debt yields between 26% and 27%.
Anyone interested in taking a flier on some god fog (神雾) bonds?
“From a market perspective, although a considerable number of bond yields are operating at high levels, it also proves that the secondary market for bonds is effective and that the issuer has been separated by a price mechanism.” Guan Li (a pseudonym) stated that the yield of hundreds of bonds exceeded 10%, which has far exceeded the normal reasonable price. Generally speaking, the yield of more than 9% indicates that serious problems have appeared.

"After the bond yield exceeds the normal level, it means that the follow-up normal financing capacity is lost, and the debt is like a flood. It is rigid. This kind of situation should cause a high degree of vigilance, just like the explosives piled up next to the arsenal. It has been a point, and it will be followed by a catastrophic chain reaction.” According to Zhang Li, it is indeed necessary to use external forces and turn in a favorable direction to prevent systemic risks.
On the state-owned investors fleeing the rising risk in the debt market:
Investors Pursue "Political Correctness"

In the spring and summer at the turn of the private company's continuous breach of contract facts or default risk, as an intermediary, the brokerage firm's investigation and exploration of the market is undoubtedly more urgent and necessary, and visiting investors is the most important part.

“The recent sales department's intensive visits to investors have fed back the typical attitude of some investors.” Another senior manager Wang Fang (a pseudonym) who worked at a top ranking securities company introduced the current investors are mainly divided into two states.

The first kind is conservative. Indifferent to bond issuers and “one size fits all” investors, the market appears risky rumors, it does not distinguish whether this risk is still there, whether it is big or small, simply throw it all away, and Never touch again.

The second type of investor has a slightly more complex mentality. Most of these investors are state-owned organizations. In making decisions on foreign investment, the priority is to seek "political correctness."

"The same as the "long-term cherished loan" phenomenon of loans to SMEs, the visit found that a large part of state-owned enterprise investors have the same mentality." Wang Fang said.

According to reports, credit debt defaults have occurred continuously for a period of time, and most of them are concentrated in private enterprises. No one knows which one will be the next.

Many state-owned investment institutions have complex mentalities but have clear positions.

"They think very directly. At this node, if I reinvest private corporate debt, if something goes wrong at the end, it may be my responsibility." Wang Fang said that because the outside world has requirements for policy makers, the risk control department Leaders at higher levels will question investment decisions. Why are they still investing in corporate bonds in such a risky environment? Why don't you vote for 3A state-owned corporate debt? Even if interest rate prices are low and revenues are low, at least there is no risk of breach of contract, and security is guaranteed. In the event of a default of private corporate bonds, the losses will be significant. The future of individuals may also leave hidden dangers due to decision errors.
Private investors are stepping into the gap and buying low:
“When everyone fears, you have to be brave.” Unlike state-owned organizations that are seeking for safety and stability, there are also many investors who have discovered business opportunities and opportunities for “wrongly killing.”

According to Wang Fang’s introduction, the two agencies that he knows have started to buy a lot of scattered debts in accordance with the combination of high-yield bonds. "They are hunters."

In fact, the "bottom-hunting" institutions are not blind, but because of solid research, rational analysis, and calm judgments.

“For example, there are some debts with high interest rates . The above institutions have made basic judgments through actual investigations or through the bank channels. Perhaps 99% of people said that the company’s risk is high, but the above-mentioned organizations believe that after the investigation , they will not Breach of contract, and then into the bond market." Wang Fang said that in the frequent violations of private enterprises at the same time, it seems to be a risky company to make a reverse decision, not only need courage, but also need wisdom.
On tight credit conditions:
The regulator believes that in this very market-oriented market, the increase in natural events is inevitable during the process of rigid payment and payment.

“Integral tension in liquidity and increased defaults in deleveraging are an inevitable phenomenon in stages. We will be very careful not to trigger systemic risks, but at present, this risk is still a very low level, including credit ratios. The bad rate is much lower," the regulator said.

Zhang Xu said that the above "liquidity overall tension" refers to the broad liquidity of the real economy. Since this year, the narrow liquidity of the banking system has been neutral and loose. The occurrence of frequent defaults is not caused by the lack of liquidity in the narrow sense, but because the credit derivatives of commercial banks are suppressed by the following three factors: capital, deposits, and credit. Willingness. Even if the central bank injects excessive liquidity into the banking system, the above three constraints are difficult to be substantially alleviated. At the same time, it may provide a hotbed for illiquid funds and excessive leverage. In fact, a structural credit policy will have a positive effect on reducing defaults, and will allow the weaker aspects of the national economy to receive more credit support. For example, the April 25 bid is a kind of policy: financial institutions will mainly use the new funds for the loans of small and micro enterprises, and appropriately reduce the financing costs of small and micro enterprises, and improve the financial services to small and micro enterprises.
And what did the PBoC do late on Friday June 1? Expand the scope of the MLF:
The scope of newly incorporated medium-term borrowing convenience collateral includes: AA-class small and micro enterprises, green and “agricultural, rural, and peasant” financial bonds, and AA+ and AA corporate credit bonds (priority for bonds involving small and micro enterprises and green economy) ), high-quality small and micro business loans and green loans.
There's a clear difference with 2016. The default wave back then was driven by indebtedness and the economic slowdown. This time regulators are causing the early default pressure:
Default risk is different from default violation in 2016

At the moment of frequent breach of contract, the industry will inevitably compare this concentration of default with the default of 2016.

In fact, there is a clear difference between 2018 and 2016.

Analysts said that in 2016, industries with excess capacity such as coal, steel, machinery, and non-ferrous metals became high-risk areas for breach of contract, and there was a default event represented by East Steel. This is mainly due to the objective background of the economic downturn and the weak awareness of individual issuers' subjective debt repayment. This year's breach of contract is more due to the broad-based credit contraction triggered by "strong financial supervision" and "strong government debt supervision."

The China Everbright Recruitment Team believes that the cases of breach of contract from the beginning of 2018 to the present are relatively limited. There are only 6 new defaulters, which is far below the level of 13 in the same period of 2016. In terms of scale, a total of 16.6 billion yuan of bonds defaulted since the beginning of the year, which is equivalent to 80% of the 20.5 billion yuan in the same period of 2016.

The factors of breach of contract are not the same, the nature of the breaching party is different, and the market's expectation of default is also not the same.
The difference is where we are in the credit and economic cycles. The 2016 default wave was the tail end of the prior credit disinflation. China was pumping liquidity into the economy in 2016, commodity prices were soaring by spring, quickly followed by home prices (some cities were already rebounding in late 2015). This year is more akin to 2014, when I posting articles such as: Rumored Mass Death of Companies in Xiaoshan District of Hangzhou If Banks Collect on Debts; Government Tells Banks to Sit Tight or Leave. That was the last time the government tried restraining credit growth. The economic weakness started with the small and weakest enterprises, as it is now, and then broadened as the global economy cooled and commodities such as oil and copper plummeted into the 2016 lows.

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