Is bond default risk a worry for China’s banks?
China’s RMB15 trillion corporate bond market faces a grueling test over the next three years as almost half of the outstanding debt matures, intensifying concerns over default risk.
Corporate bond defaults have recently been under the spotlight in China with 24 cases reported year-to-date and an outstanding amount of RMB24 billion for defaulted bonds.
And UBS says there is more short-term pain ahead with potential bonds-at-risk of around RMB1.5 trillion, or 7.1 per cent of total outstanding debts payable from bond issuers.
The firm also looked at the interest coverage of all outstanding corporate bond issuers and noted that 14 per cent of had interest coverage lower than 1 at end-2017.
Essentially, a cover that low means operating cash flow doesn’t cover interest expenses.
Furthermore, loans-at-risk for these at-risk corporate bond issuers would be RMB3.4 trillion or 2.3-times of bonds-at-risk which could become non-performing loans for the banks.
“However, as corporate bond issuers are mainly state-owned companies, repayment risks are often mitigated by government support such as equity injections and time-management of receivable payments,” UBS said in a note.
Rising defaults are due more to liquidity issues than weak profitability, according to UBS.
They claim 180 corporate bond defaults have been reported since 2013 of which 88 per cent of which are private/foreign-owned companies with liquidity problems.
Interestingly, the number of defaults peaked in 2016, gradually falling since then.
"However, the average amount per default has risen since then: this might indicate bigger companies are facing refinancing pressure.”
UBS says among the 180 default cases, most were listed in the interbank market and accounted for 81 per cent of the defaulted amount.
Moreover, most defaulted bonds were led and underwritten by banks.
Default peak ahead
UBS reckons the default peak has yet to be reached as maturity analysis indicates nearly 45 per cent of corporate bonds will mature in the next three years at an aggregated amount of RMB6.7 trillion.
But the firm thinks a potentially higher corporate bond default risk in future might not be entirely unexpected even though the overall impact may not have been well communicated to the market.
“We think very few of the reported defaults this year really caught bond holders by surprise.”
UBS has long expected more credit events to occur as China banks shrink shadow banking activities.
"Highly leveraged companies would face more pressure to seek refinancing if profitability does not improve.
"A tighter liquidity situation, especially for poor-quality companies, is also reflected in the recent spike in the credit spread for low-grade corporate bonds.
"This means that in the current environment companies are finding it more difficult to get refinancing just when the maturity profile of the corporate bond market suggests they will have higher refinancing needs in the coming years."
Asset management plans
Importantly, asset management plans own two-thirds of corporate bonds and are thus vulnerable to new AMP rules.
The new regulations might dampen demand for long duration corporate bonds, which could lead to refinancing issues for some companies
"We believe banks are the major owners of AMP plans with joint-stock and regional banks having higher exposure," UBS said.
"In addition, banks directly hold 21 per cent of corporate bonds on their balance sheets."
China's bond market size is currently RMB75 trillion with corporate paper accounting for 20 per cent.