China's default rates have long been artificially low, as easy access to credit ensured unpaid debts were either rolled over or refinanced. So much so that, before a 2014 default by a solar company in China, the country had not seen a single default for more than a decade.
That has surely but steadily changed. Analysts reckon that as many as 37 Chinese issuers have missed domestic bond payments for the first time this year as of early December. This includes high profile state-owned company Peking University Founder Group, as well as Dongxu Optoelectronic Technology Co and Xiwang Group.
More recently, this month, local government financing vehicle Hohhot Economic and Technological Development Zone Investment Development Group Co missed payments on a private onshore bond before the local government came to the rescue.
In the international market, cash-strapped Tewoo Group was unable to pay a coupon due on December 1, forcing Industrial and Commercial Bank of China, which had provided a standby letter of credit to one of the commodities group’s dollar bonds, to step in. Bondholders still had to take some significant losses and delayed repayments.
Many offshore investors view these events as a signal that China has loosened its grip on controlling corporate bond defaults, amid worries about a cooling economy and signs of a liquidity crunch onshore. Since the numbers are still small, compared with the size of China’s debt market, the bad news is a sign of the country’s market maturing, they reckon.
Perhaps the rise in Chinese defaults is not a glaring red flag for investors, but that does not mean they should shrug it off entirely. The consequences of that would be far more painful.
Part of the problem with China for investors is that they can never tell where defaults will come from next. The government has made an effort to step back from its implicit guarantees for important and government-linked entities, but the lack of support for big state-backed names, such as Tewoo and Founder Group, can be unnerving.
Such an approach makes China a minefield for foreign investors trying to understand what credits will hold up the best. Investors should never count on the government's implied support for Chinese credits, but that does not mean they don't, or haven't, in the past.
There also seems to be a strange dichotomy in reactions to the defaults, between onshore bankers and offshore firms.
While international banks and investors appear largely unconcerned about a possible contagion effect, domestic bankers are voicing much more concern. They are constantly nervous that more big defaults might be on the horizon.
Founder Group's Rmb2bn ($287m) default, in particular, produced shockwaves onshore. The borrower's offshore bonds fell in response too, and its curve was down 20 to 30 percentage points in the immediate aftermath.
Onshore banks now also fear that troubles at the Peking University subsidiary could trigger problems at other university-owned industrial groups. But international investors are not hitting the panic button just yet.
Some of the concerns offshore also seem to be muted because it is the end of the year. Many investors have already closed their books, happy with the returns they have already made. New bond issues are rare, and issuers that do come are likely to be heavily anchored. That leaves little room for cracks in the market to show.
But the reset that comes in January will not bring much of a reprieve. Offshore bankers and investors should be just as worried about China defaults as their onshore counterparts.
Chinese companies will have about $693bn of notes, both onshore and offshore, maturing in 2020, and $982bn in 2021, according to Dealogic. That excludes notes that are callable those years.
While 2019 was a blowout year for Asia's offshore bond market, volatility was never far away, whipped up by geopolitical headlines. But while US-China trade tensions have now somewhat abated, and there is more clarity around Brexit, other issues are likely to pose new challenges in the new year.
All of this does not spell disaster for China's bond market, but it should demand additional attention and greater care. China's default dilemma is not just an onshore problem, but one that can have far-reaching ramifications for Asia’s credit markets.