Via Financial Times

When China’s bond issuers run into trouble, investors face an increasingly tough task in extracting any returns.

Bond defaults across the world’s second-biggest economy are rising, with more borrowers failing either to repay creditors’ initial investments, or make regular interest payments. Typically, some investors can find a way to hold on to so-called distressed debt and recover scraps of cash. Specialist investors also buy this debt on the cheap, in what can be a lucrative if risky strategy. Now, though, returns are shrinking.

In 2016, 46 per cent of borrowers in default made some sort of principal or interest payments to bondholders, according to Wind, a financial information provider. Last year, that total dropped to 13 per cent.

For many bond investors, the struggle to get paid is becoming too costly, deterring investment at a time when increasing numbers of stretched borrowers need to keep creditors on side.

“There is too much uncertainty in debt recovery due to a lack of a mechanism for handling corporate defaults,” said Ivan Chung, an analyst at Moody’s in Hong Kong. “That has prompted many investors to walk away from the [bond] market.”

China has laws to protect investors when borrowers fail to repay, but enforcement is patchy. Communist party-controlled courts often rule in favour of defaulters that play a major role in the local economy, rather than backing investors who are owed money.

One flashpoint is in the north-eastern city of Dandong, separated by the Yalu River from North Korea, where courts have declined to hear lawsuits by investors keen to recover funds from Dandong Port. The company filed for bankruptcy in April last year after defaulting on seven bonds worth a combined Rmb8bn ($1.2bn). Creditors want to obtain its latest financial statements, supported by the country’s bankruptcy law. But local courts refuse to help, said Harold Ruvoldt, a lawyer representing various shareholders and creditors of DP.

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“It is clear we are entitled to the information but we never heard from the court,” he said.

An official at Dandong Intermediary People’s Court said there was no requirement that it accept lawsuits. “We haven’t broken any rules,” he said. 

Investors say cases like this are off-putting. “To create a well functioning distressed debt market, creditors should have the right to liquidate defaulters within a year,” said Shen Xiao, a bond portfolio manager at Beijing-based Zhongji Investments. Mr Shen said he would not seek to profit from default recoveries in China as the country’s legal and political environment fails to protect investors. “We wait for five years and nothing happens,” he said.

When corporate bond defaults first picked up in 2014, most distressed borrowers received state-orchestrated bailouts. But delinquencies are now taking off — the total value of corporate bond defaults rose to Rmb144bn last year, more than three times the level of 2016. Many Chinese cities and provinces are too stretched to bankroll troubled firms even though local officials remain keen to do so, to preserve jobs.

As a result, local governments have begun to encourage defaulters to bend the rules while negotiating with creditors, according to two distressed debt investors.

Two other bond investors said Dandong Port — which was taken over by the city government in May last year — did not consult creditors before announcing its first restructuring plan, which included handing equity to bondholders and selling the group’s main assets to state-owned China Merchants Group at a knockdown price in November.

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“This is the worst-case scenario as we get no cash and the equity won’t be worth much after the deal with China Merchants,” said one bondholder.

Mr Ruvoldt said he did not get a chance to meet Dandong Port management to present an alternative plan, or to voice opposition to the current one, despite repeated requests.

“If a company you invest in gets into financial difficulty,” he said, a creditor can lose its entire investment without “a chance to be heard . . . without considering the best financial options, without attempting to talk to all of the creditors and come up with a consensus. That is a chilling message to be sent to the financial community.”