Reuters last week reported that China’s JP Morgan is in such dire straits that it is resorting to begging from its employees.  Why would this be the case in a country that is often cited as the next superpower?

China Minsheng Investment Group Corp (CMIG) is well known as China’s version of JPMorgan Chase & Co. by Dong Wenbiao, known as the “godfather’’ of the nation’s private sector.  CMIG’s investments, spanning health care to aviation, were funded obtained in part by shadow banking, and it’s become a casualty of China’s deleveraging drive.

CMIG is not the only casualty. This is not the first time for a Chinese private company to raise money from its employees.  Another Chinese business icon the HNA Group Co had also sold investment products to staff.

Here is more from Reuters:

SINGAPORE (Reuters) – China Minsheng Investment Group (CMIG), among the country’s largest private investment firms, is raising funds from its employees as it seeks to combat a liquidity squeeze, a company representative told Reuters on Friday.

The company has set up a special funding pool for the fundraising. All of CMIG’s employees in its headquarters can put their own money into the pool and choose between buying CMIG’s debt or equity, said the representative.

Debt-laden CMIG, once among China’s most high-profile and acquisitive private companies domestically and globally, had missed payment and formed an emergency committee to deal with its liquidity troubles, raising investors’ fears about financing pressures on China’s overall private sector.

CMIG was set up in 2014 with a registered capital of 50 billion yuan and with the approval of the State Council. Its businesses span leasing, new energy, airlines, construction and investment.

Following the biggest-ever year for onshore defaults in 2018, Chinese corporate issuers again face a wall of bond maturities and more companies than ever are missing payments, raising risks for investors in the world’s third-largest bond market.

Data collected by Reuters shows that Chinese issuers defaulted on bonds with a principal amount of 23.31 billion yuan ($3.46 billion) in the first four months of 2019, up more than 70 percent from a year earlier.

Read the full story at Reuters.

The bigger story is that 2019 is shaping up to be the biggest by far for defaults in China’s $13 trillion bond market, highlighting the widening fallout from the government’s campaign to rein in leverage. Companies defaulted on 39.2 billion Yuan ($5.8 billion) of domestic bonds in the first four months of 2019.

CMIG surprised bondholders by missing a payment in late January.  While it was able to scrape enough cash together by selling land interests to repay the note on February 2014, by April its dollar bonds were put under default after an affiliate missed payments.

The company has reduced 43 billion Yuan of interest-bearing debt since the start of 2018 and it’s trying to resolve its liquidity crisis via debt workout and business reorganization.

Source: Bloomberg

Now in 2019 the defaults are taking a serious hit at China’s $40 trillion financial system.

Why are these Chinese powerhouses defaulting?

Commercial banks have remained cautious in lending to private companies. Tough monetary conditions add to the financial stress on Chinese firms, which has an impact on debt repayment ability.

Source: The South China Post

The rising rate environment in 2017 and early 2018 coupled with weaker economic growth in 2019 all were factors.  As rates rise, bond prices fall and yields on U.S. dollar-denominated debt increase. When the Yuan fell steadily against the dollar, Chinese companies earning in the local currency found repaying debt in U.S. dollars much harder.

Source: BBC

The Chinese government is offering no assistance.  The ruling party’s policies only channel capital to Chinese state-owned-enterprises.  Thus, China Inc. is allowing private companies to fall.

Source: The Financial Times

Crackdown on shadow lending has also been a factor.  It has left private companies with less cash flow and hence unable to pay their debts.  Shadow banking refers to activities performed by financial firms outside the formal banking sector, and therefore subject to lower levels of regulatory oversight and higher risks.

In the past, regulations were more relaxed on shadow banking lending. Private companies relied on those when they couldn’t issue bonds. The Chinese government started cracking down on those in 2017.  The situation has worsened since the shadow banking system was the primary credit provider for questionable corporates in China.

Source: Bloomberg

State-owned banks are only lending to companies owned by the government, which are considered safe borrowers than private firms.  As a result, corporate defaults are widespread in China.  CMIG just happens to be China’s biggest and most visible casualty yet.

To avoid the bankruptcy of their employer, all of CMIG’s employees in its headquarters can put their own money into the pool and choose between buying CMIG’s debt or equity.

 Investors should be very worried about the financing pressures on China’s overall private sector.  No industry is safe.

Source: Nikkei Asian Review

China’s credit bond default risks are likely to rise further in 2019.  Defaults are likely to expand from manufacturing firms to smaller property developers and local government’s financing platforms. The trend is clear, unless something changes, 2019 will be the new high, and sooner or later a company will default that will be the tipping point for a debt tsunami that finally drags down China’s financial sector.

 

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