China Forestry Joins Debt Default Queue
The list of Chinese companies defaulting on their bonds continues to grow, with word that timber firm China Forestry Holdings (HKEx: 930) has missed an interest payment as it tries to repurchase the notes. I’ll admit that one reason I’m focusing on this news is because of a recent conversation I had with a Chinese banker, who explained to me what happens behind-the-scenes when companies have difficulty making bond payments. That explanation shows why we haven’t seen too many bond defaults yet, despite constant media reports that China’s banks are struggling under mountains of unreported non-performing loans.
I’ll return to that part of the discussion shortly, but first let’s look at the latest news that says China Forestry is working hard to resolve the situation involving its $180 million worth of problematic bonds. (English article) The company formally missed an interest payment that was due last week for the notes, which carry a relatively attractive coupon rate of 10.25 percent.
The missed payment comes as China Forestry lobbies current debt holders for an early redemption of the bonds, which aren’t formally due until November 2015. The company first petitioned for the early redemption last November, and has extended the offer several times since then, including the latest extension announced last week. But only about two-third of bondholders have accepted the deal so far, which is still short of the 80 percent required under listing rules.
Reports on the missed interest payment also contain details that hint at financial shenanigans taking place at China Forestry. That sounds reminiscent of an accounting scandal involving another timber company, Sino-Forest, that ultimately resulted in the company’s collapse and helped to spark a confidence crisis against overseas-listed Chinese stocks in 2011. That’s a different story, though one that could be relevant to why China Forestry is currently struggling to repay its debt.
China Forestry’s missed payment comes amid growing signs of inability to make debt repayments by many Chinese firms as the national economy slows. Solar panel maker Chaori Solar (Shenzhen: 002506) made headlines in March when it became the first domestic bond issuer in modern Chinese history to miss a similar interest payment; and another risky high-yield investment product sold through leading bank ICBC (HKEx: 1398; Shanghai: 601398) also made headlines last year when it couldn’t meet its debt obligations. (previous post)
All that said, let’s return to my recent conversation with the Chinese banker, and what it could mean for the corporate debt market in the months ahead. The banker explained to me that most corporate bonds in China are currently underwritten by traditional banks, due to the country’s lack of a developed investment banking sector. When companies have trouble making debt repayments, their underwriting banks often come to their rescue. There are several reasons for such bailouts, including political pressure and also banks’ desire to preserve their reputation.
The form of bailouts is relatively simple. When a bond issuer is in danger of default, the bank will typically make an emergency loan that the company can use to buy back the debt. That might work in the domestic market, where most bondholders are state-owned entities that would realize the call for early redemption was in line with the government’s broader directives to maintain financial and social stability.
But international investors like the ones who bought China Forestry’s bonds are less likely to care about government directives, and simply want to keep getting high interest payments. What’s more, Chinese banks can only provide their usual emergency bailouts as long as distress among their borrowers remains limited. If the distress situation gets out of control, which could easily happen as the economy weakens, we could see far more of these defaults for both Chinese-issued domestic and international corporate bonds in the next 2 years.
Bottom line: China Forestry’s missed bond interest payment is the latest sign of distress in a corporate debt market whose defaults could pick up sharply in the next 2 years as the economy weakens.
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