China's guarantors get caught in default crosshairs
Reuters
* Mounting debt problems put guarantors on the line
* Light regulation prompts fears of systemic risk
* Some Rmb20.5bn of high-yield bonds are backed by guarantees
By Lianting Tu
SINGAPORE, April 11 (IFR) - A recent near-default on a high-yield bond from Xuzhou Zhongsen Tonghao New Board Co is prompting Chinese bankers to question the strength of the budding debt guarantee industry.
The Jiangsu-based materials company failed to make a coupon payment of Rmb18m (US$2.9m) last month on a Rmb180m bond issued on March 28 last year.
Bond guarantor Sino Capital Trust Co initially refused to make the payment, saying the headquarters had not authorised the guarantee its Jiangsu branch had provided. Eventually, Sino Capital Trust agreed to fund the interest payment, according to local media reports.
The travails of Xuzhou Zhongsen Tonghao, however, have put the spotlight on the role of lightly regulated bond guarantors, which have become lynchpins of China's nascent high-yield bond market.
"The quality and validity of the guarantors have become questionable after this first technical default in China's private bond market," said a Hong Kong-based bond analyst familiar with the matter.
China's domestic high-yield bond market began in June 2012 as the government sought to create a venue for smaller firms to obtain funding. However, rating requirements have made high-yield companies heavily reliant on third-party guarantees.
As of April 1, China had 384 outstanding high-yield bonds, totalling Rmb57.1bn, or 0.8% of the country's corporate bond market, according to a research report from Deutsche Bank. The bank estimates that 36%, or roughly Rmb20.5bn, of these bonds carry guarantees.
Third-party guarantees allow borrowers to sell securities at lower coupons, reducing their financing costs. In China, generally, investors require guarantees to buy onshore bonds rated AA- or below, according to a Beijing-based DCM banker at Guotai Junan Securities.
Enterprise bonds in China, which big companies usually issue to the public, also need to have guarantees from rated firms if the borrower's credit profile is weak.
Ironically, no rating is required for either the issuer or the guarantor of high-yield bonds, which small unlisted companies generally place privately, the DCM banker said.
Many bond guaranty companies, such as China Bond Insurance and Sinosure, are state owned with AAA or AA+ ratings. The concern is the many less-transparent and unrated smaller private guarantee providers, which have weak financial profiles themselves, said Qiang Liao, a Beijing-based banking analyst at Standard & Poor's.
As defaults start to mount, market players are questioning if Chinese guarantors have the ability and willingness to meet missed payments.
The Hong Kong analyst pointed out that there is not enough due diligence on the capital sufficiency of guarantors and the legal infrastructure is not there to prevent them from backing out when the borrower cannot repay the debt.
"Going forward, bond investors may be more cautious of the quality of the guarantor and may ask for a higher risk premium," Liao said.
LIGHT REGULATION
Sino Capital Guaranty Trust, which guaranteed Xuzhou Zhongsen's bonds, is a wholly state-owned entity established in 2007 with registered capital of Rmb1bn.
As of June 30, the guarantor had total assets of Rmb2bn and contingent liabilities of Rmb9.6bn. For the quarter to June 2013, it posted a net profit of just Rmb372,100, according to a prospectus of an ICBC-run money market fund, which listed Sino Capital as the guarantor.
If its financial profile has not changed, those figures mean Sino Capital is nearing its regulatory limit for guarantees. Current regulations state that a guarantee cannot exceed 10 times the net assets of a guarantor.
Also, a single borrower cannot account for more than 10% of the guarantor's net assets. A guarantor also has to provision 50% of its annual fee income as unearned premium reserve and 1% of its total guaranteeing amount as a claims-expense reserve.
Sino Capital has already breached a rule restricting a guarantor from guaranteeing any single bond issue exceeding 30% of its net assets, according to local media. In 2013, Sino Capital guaranteed a Rmb700m public bond from a shipping company, which accounted for 35% of its net assets as of end-June 2013.
Company officials did not respond to several attempts to contact Sino Capital both by email and telephone.
"The guarantee industry is under-regulated in China and even the existing regulations haven't been properly enforced. That's why we are seeing many guarantors carrying out irregular activities for years without being punished," said S&P's Liao.
Analysts now fear that the related problems could escalate if guarantors start refusing to meet their obligations on defaulting bonds.
"If the guarantors are unable or unwilling to make payments, it could cause systemic risks," said a Shanghai-based bond analyst at Shenyin Wanguo Securities.
The Hong Kong bond analyst felt the same way, saying: "The Chinese Government is encouraging the development of the private bond market before the public bond market is well developed. The lack of protection mechanisms for bond investors could eventually kill the nascent private bond market." (Reporting By Lianting Tu; editing by Christopher Langner and Abby Schultz)
