Fresh China bond default flags worries over weak state-backed borrowers

CHINA - SHANGHAI. A state-owned enterprise (SOE) in China's northern province of Inner Mongolia defaulted on part of a 1 billion yuan ($142.1 million) privately-issued bond over the weekend, the latest in a string of corporate delinquencies that has raised concerns about contagion risk as the economy slows.

Hohhot Economic and Technological Development Zone Investment Development Group, owned by the local government of Hohhot, said on Monday it was in the process of repaying the money after the Dec. 6 deadline.

The failure to meet bond repayments puts the spotlight on other debt-laden municipalities that have borrowed heavily in recent years and raises questions about where the central government would tolerate an increase in defaults as they let markets play a bigger role in discerning risk.

Chinese local governments had a funding gap of 7.6 trillion yuan in 2018, according to rating agency Moody's. The stress will likely increase as China cuts taxes and boosts fiscal spending to bolster an economy hit by the Sino-U.S. trade war.

"Chinese local governments still face relatively big pressure to pay off implicit debts," Huang Weping, analyst at Industrial Securities wrote over the weekend. He urged investors to be on high alert toward financial vehicles owned by financially weak provincial governments.

Hohhot Economic and Technological Development Zone issued 1 billion yuan worth of bonds to select investors in 2016 to repay bank loans, finance construction projects and replenish capital, according to a prospectus obtained by Reuters. The company is involved in businesses ranging from real estate to water systems development and infrastructure construction, according to its website.

Investors had the option to sell back the bonds to the issuer at the end of the third year of issuance or hold them for another two years.

China's interbank clearing house issued a notice on Saturday, saying it had not received interest payment in full from Hohhot Economic and Technological Development Zone by the end of the Dec. 6 deadline, the official Shanghai Securities News reported on Monday.

Two officials at the issuer, who declined to be identified, confirmed that the payment deadline was not met, but did not give financial details citing the private nature of the deal. One official from the financing department said the company was working to make repayments.

The bond failure comes on the heels of missed payments by two state-owned firms, Peking Founder and Tianjin's Tewoo Group, triggering concerns over the health of financially weak SOEs.

So far, defaults by state-owned entities are relatively rare in China's bond market. Reuters calculations of official data show that 42 privately-owned enterprises have defaulted this year compared with just six state-owned firms.

China's private firms have witnessed record default rates this year, according to ratings agency Fitch.