Foreigners have been slow to warm to China’s domestic bond market, the world’s third-largest by value. A look at the latest corporate default may explain why.
Wuyang Construction Group Co., a builder in the eastern province of Zhejiang, defaulted on two put-able notes totaling 1.36 billion yuan ($209 million) last month. Bondholders are now up in arms, claiming in an Aug. 23 filing posted on the Shanghai Stock Exchange’s website that the company didn’t disclose a raft of transgressions in sale documents for the bonds, which were sold in 2015. Three phone calls to Wuyang Constructions’ headquarters in Hangzhou went unanswered, and the company didn’t respond to a fax from Bloomberg News.
The incident is a good example of the teething problems China is seeing as it works to develop its $9 trillion bond market -- made more accessible to offshore investors via a connect with Hong Kong in July.
Lulled by years of implicit government support for troubled companies, locals are now having to get acquainted with defaults, which have risen six-fold since the end of 2015 as Beijing shuts down unproductive industries. It’s also placing scrutiny on underwriters, with companies like Wuyang Construction accused by investors of holding back information and providing inconsistent financial figures.
“Credit events in the onshore Chinese bond markets are a burning reminder for the need of thorough credit research,” said Luc Froehlich, head of investment directing for Asian fixed income at Fidelity International Ltd., which has set up its own research team on the ground in China.
For Wuyang Construction, the red flags were there even before last month’s default. In May 2016, the company acknowledged misusing the proceeds of the bond sale and disclosing incomplete information, violations leveled by the exchange a month earlier. The firm also delayed the release of its 2016 financial results this April.
The recriminations have mounted since the missed payments. In their filing, bond holders said Wuyang Construction didn’t disclose in the 2015 bond prospectus that it had previously defaulted on loans, or that it had been placed on a list of dishonest companies by Chinese courts for missing payments. Financial data was also inconsistent, the investors say.
Beijing’s bailout track record has made Chinese bond investors complacent, according to Yu Lu, a senior analyst at China Chengxin International Credit Rating Co. in Beijing.
“Investors in China still focus too much on yields rather than risk,” Yu said. “The implicit guarantee in this country has led to poor risk control -- they should enhance due diligence and strengthen their analysis of risk.”
This attitude can be seen in the case of Shandong Ruyi Technology Group Co. The textile company’s five-year dollar bonds tumbled a month after they were issued when discrepancies over its link to a state-owned enterprise emerged. While questions remain, improved earnings have since helped the notes recoup almost all of those losses.
But with Wuyang Construction, the issue is the bond prospectus, which didn’t disclose the previous loan defaults -- “critical information” for a debt investor, says Ivan Chung, head of Greater China credit research at Moody’s Investors Service in Hong Kong.
Tebon Securities Co. was the underwriter on Wuyang Construction’s bonds. In response to queries raised by bondholders, the Shanghai-based firm said in a Sept. 4 statement that it had carefully checked Wuyang’s bond documents and there was no false information, misleading statements or major missing items.
When contacted on Friday, Tebon referred Bloomberg News to this filing, saying it will continue to protect the legitimate interests of investors and will follow up on repayment of the bonds. The company has underwritten 4.4 billion yuan of Chinese domestic bonds this year, ranking it 70th among debt arrangers, data compiled by Bloomberg show.
“Investors typically rely on bond documents to make investment decisions,” Chung said. “Those documents are prepared by underwriters and lawyers and they are supposed to ensure consistencies between Wuyang’s audited financials and numbers on the bond document.”
That’s not good news for foreigners, who would largely be dependent on the paperwork, unless -- like Fidelity -- they have people on the ground. China has been steadily opening up avenues for international investors to access its debt, but foreign holdings, while at a record, are still just 1.5 percent of the market.
The average yield on Chinese onshore corporate bonds was 4.96 percent on Friday, almost 50 basis points above that of wider emerging-market company and government notes, according to Bank of America Merrill Lynch indexes.
Wuyang Construction’s bondholders are now trying to push the company into bankruptcy, the first time bond investors in China have initiated such action. The securities watchdog has met with management several times asking them to release 2016 results, but it hasn’t complied, Tebon said in a filing Aug. 7.
“Lack of disclosure has been rife among private sector companies in China,” said Christopher Lee, managing director of corporate ratings at S&P Global Ratings in Hong Kong. “Investors should do more due diligence when investing in private sector companies and regulators and underwriters should also carry out their responsibilities.”
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