Overcapacity & high debts force another default in Asia

August 10, 2016

Heavy debt burdens in Asia show no sign of abating as another shipbuilding company, and this time a Chinese one, defaulted on its debt obligations this week.

 

Wuhan Guoyu: defaults on RMB 400m, RMB 200m still at risk

 

Wuhan Guoyu Logistics, a shipbuilder based in China’s Hubei province, failed to pay the required funds to cover interest and principal payments on a RMB 400m 7% bond issued in 2015 that was due for payment to the Shanghai Clearing House on August 8, according to a Bloomberg report.

 

The default follows an official company warning of capital shortages on August 1 and Yangzhou Guoyu Shipbuilding, its subsidiary, suspending operations and laying off workers in May citing ‘financial difficulties.’ More worryingly for creditors, the company also has RMB 200 million of payments due on October 28.

 

Defaults & debt burdens on the rise in China

 

And this episode marks the continuation of a growing trend of debt defaults in China as companies struggle with the slowing economy and high interest payments. 18 companies have defaulted on RMB bonds so far in 2016, a major increase on the seven defaults reported in 2015, and forty Chinese companies warned of default at the end of April 2016. 

 

Rising default risk also a regional problem

 

And corporate defaults are also spreading through Asia with $3.3 billion of defaults recorded so far this year, up 23% on the $2.8 billion recorded for the whole of 2015, and up 55% on the $2.1 billion recorded in 2014.

 

Asia Debt Defaults, 2009-YTD 2016

 Source: Bloomberg

 

This follows the rapid build-up of corporate debt during the past ten years, where Moody’s estimates debt issuance has grown 13.5% annually, and at a faster rate than growth in the regional economy as a whole, which has grown by 7.2% y-o-y in the same time frame.

 

Manufacturing sector: Asia’s shipbuilders are struggling

 

And today’s default announcement shows that shipbuilders are suffering an especially tough time. Wuhan Guoyu’s case follows the default of Evergreen, the Hangzhou, China-based shipbuilder, which defaulted on RMB 400 million of debt in May 2016.

 

Defaults are also emerging outside China, with South Korea seeing an increase, where major companies such as STX Offshore & Shipbuilding, the Jinhae-based shipbuilder, ranked as the world’s fourth largest, applying for bankruptcy in May 2016.

 

Three factors ratcheting up debt default risk:

 

Slower economic and trade growth has weighed on businesses all over the region. GDP growth in Developing Asia has declined from 9.7% in 2010 to an estimated 6.3% in 2016, with global trade growth dropping from 12.8% to 2.7% during the same time frame, according to IMF data.

 

Excess capacity. Capacity expansion started on the back of the fast economic growth and expanding trade of the previous fifteen years. That growth has slowed in recent years, leaving manufacturers with unused capacity on their hands and shipbuilders suffering from weaker demand for new ships.

 

Cost-cutting to win business, caused by increased capacity, lower commodity prices and cash flow requirements. Shippers have notably cut freight rates to secure business, with rates reaching depths not seen since the Global Financial Crisis in 2009, thus lowering profitability in the industry and severely dampening demand for new vessels.

 

Outlook: A Rocky 12 Months Ahead

 

And with overcapacity rampant in many locations, particularly China, and slower economic growth expected in 2016 it is highly likely that manufacturing companies, and particularly shipbuilders, will continue to face debt management problems in the next 18 months, with further defaults likely.

 

Struggles in the manufacturing sectors, caused by weak order books and declining revenues and profits, plus the likelihood of further defaults in the pipeline, means manufacturing employment in Asia, and particularly China and South Korea, will likely be hit hard.

 

Solvency and employment issues mean that governments will scramble to put together restructuring plans to support the industries. One notable example is the South Korean government’s recent package to pump $9.5 billion into two state-run banks exposed to the shipping industry.

 

Which all adds up to a rough outlook for manufacturers, and particularly shipbuilders, for the next 12 months. That said, many industries are in need of a shake-out after years of overinvestment, and if Asia emerges with a more competitive manufacturing sector as a result of this experience, then the travails of 2016 may ultimately lay the foundation for continued growth in the region in the coming years.

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