China has tweaked its template on SOE defaults, S&P says

May 27, 2021

HONG KONG -- China is trying to mitigate the market impact of rising defaults by local state-owned enterprises (SOEs). Recent top-level guidance signals that local governments need to take a firm grip on SOE debt risk, according to a report by S&P Global.

Last month, the State-Owned Assets Supervision and Administration Commission of The State Council (Central SASAC) released guidance on strengthening management of local SOEs' debt risk.

"SASAC's guidance sends a signal that Beijing is concerned about the SOE credit events," says Li Chang, China country specialist at S&P Global Ratings. "We expect that means more discipline in borrowing habits."

S&P says corporate funding conditions have weakened in some regions since a Henan-based SOE, Yongcheng Coal and Electricity Holding Group,  defaulted in November last year. Net bond financing has been negative for more than a dozen provinces since then, including in Henan, Tianjin, and Shanxi.

"Bonds usually account for a small part of the local SOEs' debt structures. But their defaults are more likely to give rise to regional financial risks," Li said.

The central SASAC guidance puts pressure on local SASACs to keep better track of bond-default risks. The blueprint asks the local SASACs to:

*More closely monitor SOEs' debt structure and maturity profiles;

*Instruct SOEs to develop viable bond repayment plans; and

*Guide risky SOEs to negotiate with bondholders before maturity on the debt restructuring when the bonds cannot be paid off.

"While our own criteria would classify as defaults most debt restructuring cases (e.g., bond maturity extension and distressed bond exchange), we believe better workouts can improve funding prospects for weaker regions," S&P says.

"Henan SOEs have slowly begun to resume bond issuance, after Yongmei agreed to repay 50% of the defaulted bond's principal value, and extend the maturity of the other 50%."

The guidance asks local SOEs to improve competitiveness and deleverage substantively

S&P says that, despite closer monitoring by central authorities, bond defaults are likely to increase from a low base as China continues to dig out from COVID-19 while transitioning to a consumption-driven economic model. (ATI).