(Yicai Global) Nov. 16 -- A Chinese state-owned enterprise under a local government in East China’s Henan province announced a default on its CNY1.032 billion (USD156.8 million) bond principal plus interest last week, thereby unleashing turbulence in the bond market and a drop in bond funds and bank stocks.

Yongcheng Coal and Electricity Group was unable to repay the principal and interest due on its bond on schedule and this constituted a material default, the firm announced on Nov. 11, but said in a Nov. 13 statement that it had paid interest of CNY32.4 million and was raising money for the principal.

This is the firm’s first debt default. Credit agency China Chengxin Credit Rating Group had rated the firm as AAA prior to this delinquency.

The failure to pay led to a sharp decline in the bond market late last week and a steady fall in the bond prices of both the firm and its controlling shareholder Henan Energy and Chemical Industry Group. Some of these debt instruments dropped 90 percent, statistics from China Foreign Exchange Trade System show.

Many corporate bonds whose redemption prospects appear shaky also suffered a great loss. Tsinghua Unigroup, for example, took a big hit in its prices, with some falling over 40 percent.

Tidal Wave

The default bruised not only credit debts but also interest rate securities. Bank stocks fell sharply on Nov. 13. “The surging risk-free interest rate not only affected the bond market but also hit stock market evaluations, including those of bank stocks,” a bond investment manager with an overseas institution told Yicai Global.

The default subjects in the bond default boom in 2018 are mainly small and medium private firms, but the default this time involves a state-owned enterprise with a higher credit rating and it thus unloosed a tsunami of panic that swept the bond market, Ma Long, deputy director of the fixed-income investment department with China Merchants Fund, told Yicai Global.

“I dared not buy private corporate bonds but bought only state-backed corporate bonds with a credit rating of above AA+,” a bond investment manager with a joint-stock bank’s wealth management unit told Yicai Global, “But I didn’t expect default to also happen with state-owned enterprises.”

Willful Intent

The market questioned whether the firm was deliberately seeking to evade its financial obligations via the default, and it must be seen whether the local government will leverage its financial muscle to bail the company out and repay, because this will decide whether the hazard ends here or continues to ripple, the manager said, addressing whether the risk will seep into public funds and banks.

This is by no means the first such default recently. Qinghai Salt Lake Industry and Brilliance Auto announced default on bonds one after another before Yongcheng Coal and Electricity.

“Trust in AAA credit rating has collapsed,” bond industry insiders said to Yicai Global. Because they know Yongcheng Coal and Electricity just issued CNY1 billion medium term notes late last month, and the local government just completed major asset restructuring of the company, lopping off its underperforming chemical business and pledging to invest over CNY15 billion in it.

“Yongcheng Coal and Electricity’s default happened all of a sudden, and the cost for the firm’s managers to make the default decision was quite low in the view of market insiders,” the bond investment manager at an overseas institution told Yicai Global, “Default is not the only choice available to state-owned enterprises.”

Editors: Tang Shihua, Ben Armour, Xiao Yi