China latest bond default is a cautionary tale for investors

HONG KONG • 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 puttable notes totalling 1.36 billion yuan (RM870.4 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 Hang- zhou 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 US$9 trillion (RM37.8 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 sixfold 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 acknow- ledged misusing the proceeds of the bond sale and disclosing incomplete information, violations levelled 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. Finan- cial data was also inconsistent, the investors said.

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 enter- prise 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, said 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 state- ments or major missing items. — Bloomberg