Stress Is Building in China’s $12 Trillion Onshore Credit Market

Pressures are increasing for China’s credit market, with onshore defaults mounting and concerns resurfacing about the country’s ailing property sector.

Stress domestically rose to level 4 in June from 3, Bloomberg’s China Credit Tracker shows, the highest since February. The gauge indicates rising levels of financial strain via a band from 1 to 6. The worsening was caused largely by a pair of builders failing to make a combined 4.4 billion yuan ($608 million) of bond payments, the largest monthly total this year.

Other setbacks have included large domestic banks halting purchases of local notes sold in the Shanghai free trade zone. Local-government financing vehicles, the main issuers of such debt and whose debt is a growing risk for China’s economy, could face liquidity tightness from having to seek alternate financing channels.

Strains persist in the smaller offshore credit market, even though the tracker’s stress level for that segment fell to level 3 from 4. The decrease was due to a rally in early June for developer-dominated high-yield dollar bonds, which have posted losses the past three weeks, according to a Bloomberg index.

Declines have accelerated this month amid debt worries involving major builders Sino-Ocean Group Holding Ltd. and Country Garden Holdings Co. Meanwhile, two smaller peers in late June failed to make bond payments.

Analysts at Goldman Sachs Group Inc. and HSBC Holdings Plc recently increased their projected 2023 default rates for junk-rated property bonds to about 30%. “If property sales remain lackluster with a lack of stimulus from the authorities, we do not rule out the possibility of a further uplift in default rates,” HSBC’s Keith Chan wrote in a report last week.

The chairman of the country’s second-largest builder, China Vanke Co., called the housing market “worse than expected” as he joined a chorus of voices darkening on the sector. June sales among the 100 biggest developers slumped 28% from a year earlier, just months after the industry logged its first increases in nearly two years.

As for LGFVs, the potential loss of a financing channel comes at a time some located in poorer areas are having trouble accessing the public bond market. LGFVs from districts and counties with fiscal revenue of less than 5 billion yuan are relying almost exclusively on private-debt issuance this year, according to Tianfeng Securities Co. analyst Sun Binbin.

Authorities are trying to balance steps to manage hidden debts with efforts to prevent any impact on the broader economy. China’s biggest state banks are offering some LGFVs 25-year loans and temporary interest relief to prevent a credit crunch in the sector. Bloomberg News also reported authorities are weighing plans to support cash-strapped cities and counties by allowing additional local-bond issuance to help pay down hidden debt in higher-risk areas.