Dongbei Special Steel, an unlisted Liaoning based steelmaker with a majority ownership by the provincial government, announced to default on a batch of two-year private placement notes worth 870 million yuan ($130 million) due July 25.
Despite having issued a formal pledge end of May stating that it would cease to continue defaulting or seeking debt-to-equity swaps, this is at least a seventh default on debt instruments that it has announced thus far into the year, after leaving bondholders emptyhanded since it bailed on the first one originally due March 28. All seven defaults amount to close to 4.77 billion yuan involved.
Formed in 2004 by consolidating and restructuring three regional special steel manufacturers, the provincial government of Liaoning owns a 68.81% majority of the newly established Dongbei Special Steel, which was intended to specialize in steel used for rockets and submarines among others. The remaining of the entity belongs to 1) a state owned investment company, China Orient Asset Management Corporation, as well as 2) the provincial government of Heilongjiang, another crucial region along China’s rust belt which has long been integral in the nation’s heavy industries.
Analysts believe that the company’s recent troubles have been long seeded since 2008, as the company announced to initiate tremendous investments for technological upgrades. In the same year, it moved its manufacturing base away from Dalian, in what the market later believes to be the largest factor driving up its debt since 2007.
As of June 2014, more than 30 billion yuan has been invested in what appeared to be the largest technological makeover within the special steels industry worldwide. Since then, it eyed penetration into the high end market as a priority for the next three years, potentially covering over 35% of civilian used super-alloy and high-tensile steel and exporting one-third of its products overseas.
By the end of September 2015, Dongbei Special Steel’s total assets and total debts amounted to 52.7 billion yuan and 44.4 billion yuan respectively, giving it an 85% assets to liabilities ratio, according to data from the China Development Bank, a policy bank that backs predominantly SOEs through short and mid-term lendings. The company then estimates that it would only have the ability to handle 670 million yuan in liquidity over the next three years; judging by a 5% interest rate, that would give it enough leverage to handle only 13.5 billion yuan to repay its debt, or merely 30% of what it owes in total.
Means to repay the remaining 70% was what triggered an enormous controversy after the company announced to default on Monday. Clearly violating its abovementioned pledge in May, the company proposed to swap the outstanding debt for equity, prompting investors to urge the nation’s banking and securities regulators to ban institutions from buying bonds from any Liaoning based companies. The proposal has since been removed on July 26, raising concerns of potential damage of the provincial credit market, wrote financial magazine Caixin citing a report by China Chenxin Credit Ranking. Simultaneously, Liaoning based officials are urging the central government to consider the equity swap, giving it the potential to set a precedent as no legislature has been written or executed on similar matters thus yet.
Bonds issued by SOEs were long deemed to carry implicit guarantees, even though nothing has been written explicitly about it. This perception makes sense, given that the government do often intervene to save companies which are “too big to fail”, even though key policy makers, notably central bank officials have begun to take tougher stances towards this, says Hu Kai at Moody’s. Local governments influence higher ups as well, usually by blocking or tweaking bankruptcy proposals to save SOEs.
The nation’s finance minister Lou Jiwei said at a conference on July 24 involving heads of finance from 20 plus countries that even though the Chinese government would provide assistance to state-owned companies in trouble, it would not necessarily directly bail them out unless they prove to exert a systemic risk on society.
Thus far into 2016, 17 Chinese firms have defaulted on domestic bonds, down from 18 in 2015, according to financial information provider Wind.