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Chinese corporate defaults on an upward curve

Chinese companies defaulted on 39.2 billion yuan (CNY) – equivalent to US$5.8 billion - in the first four months of this year, or 3.4 times the total for the same period of 2018, reports Bloomberg.

The group says that 2019 is on course to be the biggest by far for defaults in China’s $13 trillion bond market, highlighting the widening fallout from the government’s campaign to rein in leverage.

The current pace is also more than triple that of 2016, when defaults were more concentrated in the first half of the year, unlike 2018. China continues to press banks to extend credit to the private sector, and to particularly favour small and medium-sized enterprises (SMEs). Earlier this week the central bank loosened some reserve-requirement rules for lenders.

At the same time, President Xi Jinping’s administration intends to shrink China’s shadow banking system, where credit decisions were made with less regulatory oversight and where it was easier to build up unsustainable leverage.

Recently, regulator the China Banking and Insurance Regulatory Commission (CBIRC) has called on the country’s major lenders to accelerate recognition of non-performing loans (NPLs) by classifying payments overdue for more than 60 days as NPLs against 90 days previously – reflecting the authorities’ wish to improve both the quality of loans and banks’ risk controls.

Not the full story

Bloomberg reports that in 2016 China’s focus was principally on reducing its excess industrial capacity, which had an impact on the credit markets. The current funding squeeze and resulting surge in defaults began in late 2017.

“Short bond tenors mean the companies need to refinance frequently,” Hong Kong-based analyst Nino Siu at Moody’s Investors Service wrote last month. “Banks are reluctant to lend to weaker companies. Additionally, shadow banking, on which weaker Chinese companies rely, continues to contract as the government tightens regulation.”

There are concerns that the bad news on defaults tell only part of the story of China’s credit strains. Some borrowers have avoided a strict definition of default by cobbling together payments on bonds within their grace periods, while some issuers have had help from officials. Neither practice is revealed in the official figures

“Investors should not be complacent about China’s credit risk,” Goldman Sachs Group Inc. analysts Claire Cui and Kenneth Ho this week. “Credit stresses are higher than the defaults are showing, as evidenced by a number of situations where companies failed to meet scheduled bond payments, but were subsequently able to repay in full and avert a default.”

Opening up the financial sector

On a more positive note the CBIRC’s chairman Guo Shuqing, has announced 12 new measures to further open up China’s US$ 44 trillion financial sector to foreign investment.

The measures are extensive and cover many areas of China’s financial system, including banks, trust companies, consumer finance companies and insurance companies and intermediaries. Two key reforms targeting the insurance industry are as follows:

  • The CBIRC will allow foreign financial institutions to invest in foreign-invested insurance companies (those in which foreign shareholding is already at least 25%);
  • The CBIRC will eliminate the requirement that, prior to entering the Chinese market, foreign insurance brokerages have been in operation for at least 30 years and have minimum total assets of US$ 200 million.

Guo Shuqing also indicated that the CBIRC will allow foreign insurance group companies to invest in or establish insurance companies. Similarly, it will also allow foreign-invested domestic insurance group companies to establish insurance institutions, provided that such investments meet certain qualification requirements.

He added that the CBIRC will “encourage and support” foreign financial institutions to collaborate with Chinese non-state-owned banks and insurance companies in equity, business, technology and other areas, although did not offer further details.

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