Credit risk, including default risk, remains high in China. S&P Global Ratings has a negative bias on most sectors in our rated portfolio, meaning that credit downgrades are more likely than upgrades in 2020. This factors in refinancing uncertainty, especially for speculative-grade issuers, whose exposure to U.S.-dollar denominated debt has increased in recent years. In some cases, negative outlooks are prompted by flagging support amid weakening appetite for bailing out troubled government-related firms.

Maturity walls will edge higher this year, on the back of last year's record step-up. Stronger borrowers will get a little help climbing these walls. Their debt serviceability will increase due to stabilizing leverage and accommodative monetary settings.

However, there are few catapults for the weakest borrowers. Risk aversion will complicate efforts to refinance lower speculative-grade issuers. The rising default rate is contributing to wider spreads at the lower end of the credit spectrum.

Default Risk Remains Elevated

Onshore defaults in 2019 topped Chinese renminbi (RMB) 130 billion (US$18.75 billion), exceeding the total amount of 2018. We expect corporate defaults to rise again in 2020, given tight refinancing conditions for weaker borrowers.

Effective onshore maturities (including bond puts) could rise to RMB6.5 trillion this year (assuming all puttable bonds will be exercised), versus RMB6.3 trillion in 2019 (see chart 1). This doesn't include short-term debt that will be issued in the course of 2020 and come due before the year is over. By sectors, local government finance vehicles (LGFVs) still face the highest maturity wall in 2020 with about RMB2 trillion, composing over 35% of total maturities (see chart 2).

Chart 1

Chart 2

Offshore maturities will rise slightly this year from 2019's US$89 billion, then jump in 2021. As such, maturities (including puttable bonds) will exceed US$200 billion over both 2020 and 2021 (see chart 3). Refinancing risk could be a headache for offshore issuers during the next three years, especially considering last year's tightening policy on offshore issuance for property firms and LGFVs. Furthermore, the higher maturity wall for lower-rated or non-rated issuers points to a higher default risk (see chart 4, and "China Bond Defaults: Becoming A Norm," Nov. 25 2019).

Chart 3

Chart 4

A Partial Trade Deal Will Not Resolve Risk Aversion

Investor sentiment could improve following the "phase 1" U.S.-China trade pact, signed On Jan. 15, 2020. Even so, containing financial risk will remain a key challenge for the Chinese government, given rising corporate defaults and the high-profile troubles at several banks in 2019, including Baoshang Bank Co. Ltd., Jinzhou Bank Co. Ltd., and Hengfeng Bank Co. Ltd. At a working conference this month, the People's Bank of China reemphasized the need to prevent and neutralize financial risk.

In our view, authorities will avoid a repeat of a punitive-style takeover or abrupt exit. The takeover of Baoshang in May 2019 led to widespread funding stress for small and midsize banks and companies, and risk repricing has lingered (see "China Credit Outlook: Liquidity Crunch Just The Latest Headache For Corporate Issuers", July 8, 2019). This enduring "flight to quality" will weigh on efforts to boost credit support and lower financing costs for small and midsize enterprises.

Companies will continue to rely on short-term funding in 2020. This is another result of the flight to quality, which makes lenders wary of long-term obligations, and encourages some to borrow short on the expectations that funding costs will come down. Most of our rated sectors have a weighted average maturity of less than three years, and for several sectors it is at or under two years.

We believe refinancing uncertainty will continue to be a top risk for weak firms. Shorter maturity profiles are credit negative, considering the median liquidity assessment is only 1.32x for the companies we rate. That is to say, we project liquidity sources to be only marginally sufficient to cover the liquidity uses of rated companies. Liquidity sources include cash balance, committed credit lines, funds from operations, working capital, contracted asset disposals or equity; liquidity uses include short-term debt, working capital, non-discretionary capital expenditure, and contracted purchases.

Chart 5

Chart 6

More Market-Based Resolution--Or More Tolerance For Default?

Chinese regulators recently released draft guidelines that, in our view, recognize the need to improve the post-default and recovery mechanism in China (see table 1). However, the guidelines do not have specific legal implications and punitive consequences of non-compliance, raising questions over whether they'll be followed.

The focus on post-default resolution also shows the government is increasingly willing to resolve distressed companies with market-based losses rather than unconditional bailouts. We expect the Chinese government to be increasingly tolerant of defaults including by state-owned enterprises (SOEs), as underlined the failure of Tewoo Group Co. Ltd. to meet debt obligations late last year (see "Landmark SOE Default In China Sets Stage For More," Dec. 11, 2019).

Table 1

Operating Performance Is Not Getting Worse

We project stable leverage for our rated entities in 2020. The deleveraging trend that began in 2016 is unlikely to get back on track, after stalling last year. However, things won't get worse, due mainly to slightly improving top lines. In some cases, these improvements come on the back of a low base after a rocky performance in 2019 for sectors such as auto/auto parts and high-tech. Stimulus policy and moderating trade tensions should also boost revenues in some sectors (see tables 2 and 4).

We estimate revenue will expand by a median 7.1% for our rated entities this year, compared with 6.5% in 2019 and 9.0% in 2018. The median EBITDA margin will likely remain stable in 2020 after decreasing to 20.7% in 2019, from 22.5% in 2018. These trends should allow for a mild recovery in debt serviceability to continue (see chart 7).

Table 2

Chart 7

We rule out a strong operating recovery for Chinese corporates in 2020, given the backdrop of economic uncertainty and tepid industrial demand (see chart 8). Our economics team estimates China's GDP growth will slow to 5.7% in 2020. Consumption growth, a favored economy driver, will likely subside as a result of slow employment growth and moderate wealth gains. Manufacturing investment may stabilize but a strong upturn is improbable. Cooling property activity will likely drag on investment growth, with some offset from infrastructure stimulus (see "Asia-Pacific Quarterly: The Cost Of Uncertainty," Dec. 2, 2019). However, high leverage in the economy and caution on adding more debt overhang will limit stimulus efforts (see chart 9).

Chart 8

Chart 9

Which Of Our Rated Companies Are Most Vulnerable?

Overall, times remain tough for China's corporate sector. High-quality companies have good funding access, but their capital needs are constrained by the country's economic slowdown. Weak companies are not getting financing at costs and durations needed for a sustainable capital structure.

Most rated sectors remain on a negative bias in 2020, as has been the trend for two years (see table 3). The few sectors with positive rating bias do not have a material representation within our rated coverage. Moreover, our target list is expanding of "weakest links"—i.e., issuers rated 'B-' or below and with negative outlooks or with ratings on CreditWatch with negative implications.

Table 4

Chart 10

Table 5

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Related Research

• Landmark SOE Default In China Sets Stage For More, Dec. 11, 2019
• Asia-Pacific Quarterly: The Cost Of Uncertainty, Dec. 2, 2019
• China Bond Defaults: Becoming A Norm, Nov. 25 2019.
• China Credit Outlook: Liquidity Crunch Just The Latest Headache For Corporate Issuers, July 8, 2019