Debt at China’s state-owned firms in question after BMW partner fails to repay billion-yuan bond

Frank Tang
·4-min read

A bond default by a big state-owned automaker, which is also the parent company of BMW’s joint venture partner in China, serves as a fresh warning about debt risks in the country despite strong headline economic growth numbers, according to analysts.

Brilliance Auto, also known as the Huachen Automotive Group, rattled China’s debt market last week by failing to repay 1 billion yuan (US$148.8 million) to its bondholders when the bond matured.

What made the news particularly shocking was the fact that the company is directly owned by the Liaoning provincial government, and that its own interim financial report claimed that it had 51.4 billion yuan (US$7.65 billion) worth of “cash and equivalents” as of the end of June.

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The bond, which was issued in 2017 with a coupon rate of 5.3 per cent, matured on October 23. And its default appears to be just the tip of the iceberg. The company still has 13 batches of outstanding bonds totalling 16.2 billion yuan, and many of them will mature in 2021 and 2022.

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Brilliance Auto, which has reported 190 billion yuan worth of total assets, said in a statement on Monday that it suffers from tight liquidity and difficult financing, but is still trying to repay bondholders.

But China’s credit rating agencies, which are usually generous in doling out good ratings, have rushed to cut the rating for Brilliance Auto in recent days.

The company’s default invokes memories of a slew of defaults on 7.1 billion yuan worth of bonds by Dongbei Special Steel in 2016 after its chairman committed suicide in his office. That marked the biggest bond-default case in China up to that point, and it came after China launched a deleveraging campaign in 2015 to curb excessive borrowing by local governments, financial institutions, businesses and individuals.

The subsequent restructuring of Dongbei Special Steel involved deep “haircuts” for bond investors before the company was sold to a private steelmaker.

Brilliance Auto’s default is also fuelling the perpetuation of a popular expression among bond investors: “no investment should be made beyond the Shanhai Pass”.

We shouldn’t take for granted that state-owned enterprises will never default, nor wait for government bailouts if it happens

Zhao Xijun, finance professor

The Shanhai Pass is a section of the Great Wall of China in northern Hebei province that divides the northeast from the rest of the country. Investment conditions in the northeast – including Liaoning, Jilin and Heilongjiang provinces – have been historically poor because local authorities there are said to lack the fiscal resources to save troubled businesses.

Liaoning has said its economy contracted by 1.1 per cent in the first nine months of 2020 from a year earlier, making it one of the worst-performing provinces in China as the country as a whole reported growth of 0.7 per cent over the same period.

Zhao Xijun, a finance professor at Renmin University, said China’s overall debt market is stable amid a broad economic growth, but financial troubles could emerge in specific regions and sectors. And the auto sector was among the sectors worst hit by the coronavirus pandemic.

The auto sector now appears to be on the road to recovery as many cities have extended preferential tax policies while relaxing purchasing restrictions. But new energy vehicles and foreign brands generally move ahead of the curve, which puts conventional automakers such as Brilliance at a disadvantage.

“We shouldn’t take for granted that state-owned enterprises will never default, nor wait for government bailouts if it happens,” Zhao said.

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Data from the Ministry of Finance shows that local government debt across the country totalled 25.6 trillion yuan (US$3.8 trillion) by the end of September, and the vast majority of that debt total is tied up in bonds with an average maturity period of 6.8 years. The estimated size of corporate bonds with implicit liabilities for governments, including that of state-owned enterprises, is about the same.

The ministry also said on Thursday that profits among China’s state-owned enterprises for the January-September period were down 16 per cent year on year, at 2.28 trillion yuan (US$340 billion).

The debt among rated state-owned enterprises will grow by about 5 per cent this year, according to a report released by Moody’s in September. Companies engaged in more public policy projects will generally have faster leverage and debt growth than others, the rating agency said.

Liu Xuezhi, a researcher with the Bank of Communications, said the debt of state enterprises should be increasingly viewed as corporate debt, rather than government liabilities.

“The Chinese authorities started to clean up local government debt piles from 2013 and have largely curbed its expansion,” Liu said. “It could bring systemic risks if the line between government and corporate debt is again blurred.”

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