Unprecedented Default and Downgrade Wave Hits China

Caijing: 债市违约连环炮!千亿债券取消发行评级下调潮来袭

First: 11 companies and 22 bonds have defaulted in 2016. Most of the defaults are in energy, mining, coal, etc.

Bloomberg: China Steelmaker Default Risks Flag Debt Woes at State Firms
Xining Special Steel Co., whose products are used in the rail, automobile and energy industries, has a 5.7 percent probability of missing debt payments in the next 12 months, the highest among 420 listed Chinese issuers with note payments due in the coming year, according to the Bloomberg Default Risk model. That compares with an average 1.2 percent probability for all the firms. The model tracks metrics including share performance, debt and cash flow.

Second: Poor financials, market volatility and rising bond yields have led to a wave of bond cancellations, totaling more than 100 billion yuan.
Wind Information carding Chinese currency network, Shanghai Clearing House and China Bond Information Network bulletin in April found that 103 companies postponed or canceled bond issue, totaling 100.91 billion yuan, the amount is about 3.4 times last year at this time, are due to market volatility plus large, covered species in the vote, short financial, short melt. Bond issuance canceled concentrated in traditional industries relatively poor profitability of the industry, the energy industry such as mining and construction related industries. According to Bloomberg data show that there are 62 Chinese companies in March canceled 44.8 billion yuan bond issue plan, the size equivalent to three times last year.

...Analysts believe that the size of the planned bond issuance to abandon the surge reflects nearly 25 years in the face of the worst economic slowdown in the background, investors are increasingly worried about the risk of default. In the past two years, even if China's central bank to ease monetary policy to support the economy, there are still at least 12 Chinese companies with bond defaults.

Third: the downgrade wave is coming

Bloomberg: China Ratings Downgrade Wave Seen as Next Driver of Bond Slump
China Securities Co. and HFT Investment Management Co. predict downgrades will surge as a slumping economy makes financial reports due by April 30 a gloomy read. Companies in China must repay 547 billion yuan ($86 billion) of onshore notes in May, the most in any month ever, data compiled by Bloomberg show. Investors are avoiding risky debt, with the yield premium on three-year AA- rated local bonds, considered junk in China, widening 43 basis points in April, the most since 2014.

“An explosion of credit risks is spreading,” said He Qian, a Shanghai-based fund manager at HFT Investment Management Co., which manages 46.9 billion yuan of assets. “The risks are spreading from privately held companies to state-owned companies, from overcapacity industries to all other industries.”

...At least seven companies missed bond payment this year, up from only two in the same period of 2015 as Premier Li Keqiang tries to rid industries with overcapacity of zombie producers. Onshore agencies have cut 33 issuer ratings, almost double the 17 for the first four months of 2015, according to China Chengxin International Credit Rating Co. There have been 34 upgrades versus 37 percent a year ago.

"We will see a wave of rating downgrades in the middle of this year,” said Wei Zhen, a money manager at Bosera Asset Management Co.
Maybe China has landed. FT Alphaville looks at SocGen predictions for a hard landing back in 2013, “What if China lands hard?” they asked in 2013, and finds many of their market predictions were sound, even if there was no official hard landing. (If the Chinese economy has a hard landing in the forest, does it make a sound?) There have been positive data spikes such as the rise in real estate investment, which is positive for GDP. There won't be a cost free recovery: inflation is going to advance rapidly if this is a recovery. Nonetheless, the bull take is that China has once again managed to save its economy.

I will stick the with negative view. China needs to rebalance away from infrastructure development; it is increasing it. The speculation in commodity markets, plus boosting of steel production and exports with bank financing, is not positive. Meanwhile, in the background, outflows and credit conditions remained neutral to worse.

We have witnessed an incredible bear market rally. Time is running out on the ChiNext analog, but I think it will recouple in May. I am betting (with June puts) that May is going to be volatile for global markets. Whether 2016 turns into another "Tragic Year" will likely depend on the credit and currency markets.

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