Analyzing corporate credit risk:
The myths in China
Dr. Michael C S Wong
Associate Professor, College of Business, City University of Hong Kong Chairman, CTRisks Rating
Disclaimer by the speaker
CTRISKS Rating Limited is a credit rating agency licensed in Hong Kong under the Type 10 Regulatory Activity of the Securities and Futures Ordinance in Hong Kong
Dr. Michael C S WONG is a responsible officer licensed under the Type 10 Regulatory Activity of the Securities and Futures Ordinance in Hong Kong The following speech is delivered in the personal capacity of Dr. Michael C S WONG and does not represent the opinion of CTRISKS Rating Limited
Agenda
7 myths about China corporate credit risk
Observations and summary
NB: Graphs and tables are extracted from a research paper of Wong and
Zhou (2014) “Analyzing corporate credit risk: The myths in China.” under review by Accounting and Business Research
Myth 1: Bank loans to corporations in China have
high default rate
Major banks in China
ICBC: Industrial & Commercial Bank of China (RMB clearing bank in
Singapore)
BOC: Bank of China (RMB clearing bank in Hong Kong via BOCHK) CCB: China Construction Bank (RMB clearing bank in London)
ABC: Agricultural Bank of China
BOCOM: Bank of Communications (RMB clearing bank in Taipei and
Myth 2: China corporate bonds have
high default rate
On March 7, 2014, a surprising news about corporate bond
default happened in China. BBC News (2014) wrote the
heading as “Chaori Solar in landmark Chinese bond default”.
This is the first default case of China publicly-listed domestic
Recent cases of government
bailouts in China
Time Issuer Event Outcome
April 2012 Shandong Helon (a
chemical fiber manufacturer)
It was unable to pay RMB 400 million in commercial paper maturing on April 15, 2012. Bailed out by the China government November 2012 Xinjiang Chalkis (a state-owned food company)
It was unable to repay RMB 400 million in short-term financing bills on time on November 7. Bailed out by the China government March 2013
Suntech Power (the largest solar panel maker in the world)
It was unable to pay USD $541 million of offshore bonds due March 15 and
breached terms of other outstanding loans. Its shares and bonds were traded in the USA.
Bailed out by the China government
Myth 3: State-owned enterprises should be safe
because they will be bailed out by the China
government
Xie (1999) quotes, “…from 1995 to 1998, more than 2,000
urban credit cooperatives were merged into 88 city commercial banks…”
Hainan Development Bank (closed by PBOC in 1999)
Guangdong International Trust and Investment Company
Myth 4: Underperforming companies warned by
the securities regulator in China will likely go
bankrupt soon.
China Securities Regulatory Commission (CSRC) initiated in
1998 a warning signal “Special Treatment ST” to those listed companies under financial distress.
The indicators include:
a) Companies that had negative cumulative earnings over two
consecutive years or net asset value (NAV) per share below par value (book value).
b) Companies that had negative earnings for one year, but the current
Statistical models to predict ST
Study Altman, Lin and Zhang
(2007)
Tang, Zang and Ceng (2011)
Zhu and Chen (2014)
Sample for building a model 30 ST and 30 non-ST in 1998 and 1999 683 ST and 4123 non-ST in 2004-2009 917 ST and 7315 non-ST in 2008-2011
Statistical method Discriminant Analysis Logistic Regression Discriminant Analysis X-variables incorporated
Total Liability / Total Asset + +
Operating Profit / Interest Paid
-Net profit /Average Asset
-Operating Profit / Total Asset
-Working Capital / Total Asset -
-Current Asset / -Current Liability
-Inventory Turnover (days) +
Retained Earnings / Total Asset
-Year of continuous listing +
Stock Turnover rate +
Annualized stock return volatility +
-Myth 5: Listed corporate bonds in
China should be safe
Corporate credit risk is rising in China
China export drops drastically w.r.t. GDP
Large companies are highly leveraged
Shadow banking are out of control
China Export/GDP Ratio
(Source: World Bank and the author’s estimates)
23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 Export/GDP (%)
No monetary easing in China
(CNBC Sep 11) Premier Li Keqiang said in World
Economic Forum held in Tianjin (Sep 10, 2014):
"Instead of adopting strong economic stimulus or easing
monetary policy, we have vigorously promoted reform and economic readjustment."
Myth 6: AAA/A-rated corporate
bonds in China should be safe
Average yield spreads of rated
bonds
Myth 7: Corporate financials are key determinants
of their default and bankruptcy
Journal Authors Sample Arguments, findings and implications Journal of Financial Economics Fan, Wong and Zhang (2007) 790 IPOs and their 7255 CEOs and directors in 1993-2001
The authors find that 27% CEOs of 790 newly partially privatized firms in China are former government officials. Firms with strong political connections tend to have worse financial performance in the 3-year period after their IPOs. Journal of Development Economics Li, Meng, Wang and Zhou (2008) 3258 privately-owned China enterprises surveyed in 2002
The authors find evidence that firms with strong link with ruling Communist Party tend to have better financial performance and they find it easy to get bank loans.
Journal of Banking and Finance Firth, Lin and Wong (2009) 2400 enterprises surveyed in 2003
The authors conclude that firms with the state as a minority shareholder find it easier to access bank loans and political connections are especially important to access bank loans in areas with a less developed banking sector.
Journal of Financial and Quantitative Bailey, Huang, Yang 379 announced bank loans in China from
The authors argue that China stated-owned banks mostly serve political goals and lend to avert unemployment and instability. They find empirical evidence that poorly-managed
Observations and summary
Financials are less important in predicting credit risk in China.
State-supported and politically-connected entities tend to be
poor in financial ratios but their cash flows are relatively stable.
Top-tier banks are usually strong in their asset quality but
second-tier banks and nonbank financial institutions are not.
Observations and summary
Governmental officials are very inclined to bail out troubled
companies because of complicated political consideration. But it is not a guarantee.
Credit risk of a single corporate bond is high but a diversified
bond portfolio may offer investors lucrative risk-adjusted returns.
