Bond Default Recaps: Recapitalization Patterns
As the economy slows and bad debt increases, the outcome of the current round of defaults, along with related programs like the debt-for-equity swaps, tell us a lot about what China will do and not just what it says it will do. We believe this initial pool of defaults provides a clue to how the state will handle defaults going forward, if, as we suspect, there is a significant increase in defaulting securities and companies. This has implications for China’s companies, banks, and allocation of credit within the economy.
Orient Capital Research analyzed 79 defaulted bonds from 33 companies. We wanted to understand:
1) Who were the defaulting entities?
2) How these defaults were handled?
3) How they were recapitalized?
Our conclusion is that bankruptcy is the least-favored option. Not surprisingly, the law actually mandates that bankruptcies must be approved by the local party official before reaching the courts. According to a judge in Zhejiang Province, cited by law professor Susan Finder, "If a developer is having a crisis, government will involve itself first, and only if administrative measures don't work, will they think of judicial measures.”
More than one-quarter of our sample are still under negotiation. Only a small percentage were restructured or recapitalized. Clearly, Beijing is struggling to come up with a reasonable approach to failed corporates.
Our data shows:
1. Bankruptcy. Only 2.9% underwent full bankruptcy.
2. Recapitalization. One-third achieved full or partial recapitalization through a variety of sources.
3. Negotiations. More than one-quarter of the firms are still under “negotiation” by interested parties.
4. Local SOEs. The majority of firms with defaulting bonds are private. However, both private firms and local SOEs have nearly equal amounts of debt.
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