Growth in Chinese company debt has been unprecedented. A Thomson Reuters analysis of 945 listed medium and large non-financial firms showed total debt soared by more than 260%, from 1.82 trillion yuan to 4.74 trillion yuan, between December 2008 and September 2013.
While a credit crisis isn't expected anytime soon, analysts say companies in China's most leveraged sectors, such as machinery, shipping, construction and steel, are selling assets and undertaking mergers to avoid defaulting on their borrowings.
More defaults are expected, said Christopher Lee, managing director for Greater China corporates at Standard and Poor's Rating Services in Hong Kong. "Borrowing costs already are going up due to tightened liquidity," he said. "There will be a greater differentiation and discrimination of risk and lending going forward."
China Erzhong Group (Deyang) Heavy Industries, a loss-making manufacturer of equipment for the steel and power industries, faces higher borrowing costs after a wholesale restructuring, said Huang Guozhan, an executive at the company's board secretary's office. The Sichuan-based firm, which expects to report a 2013 loss of 3.15 billion yuan and may see its shares suspended, held debt of 11.4 billion yuan in September, according to stock market filings.
In July, China's State-Owned Assets Supervision and Administration Commission ordered China Erzhong, together with its parent company, to merge with China National Machinery Industry, another Beijing-controlled enterprise group.
A management reshuffle followed, while a proposed 1.9-billion yuan asset sale was cancelled. Accumulated losses may drive up the cost of the company's loans, Huang said, should banks cut the company's ratings.
"Tight credit growth and higher borrowing costs will make it a tough year," said Stephen Green, head of China research at Standard Chartered Bank.
China's massive holding companies, power producers and construction materials firms are among the most highly levered in the world's second-largest economy, with each sector reporting twice as much debt as equity at end-September, Thomson Reuters data show. Exacerbating China's corporate troubles has been the questionable use of 4 trillion yuan in stimulus that Beijing pumped into the economy following the onset of the global financial crisis in 2008, explained Lee of Standard & Poor's.
"Many companies invested heavily into competitive and low-return projects because funding was readily available," he said. "These investments aren't doing well and are making little contribution to profitability."
Although leverage at China's mid-sized and large companies started to decline in the second half of last year, building down debt positions will be difficult, said Merrill Lynch analyst David Cui. "The beast grew so fast you can't control it easily now. A sense of urgency will develop only if there is significant disturbance to the financial system."
China's bonds, which in the past behaved more like pure interest rate products, have started to price in credit risk, with the coupon gap between AA and AAA-rated companies for five-year bonds doubling in recent weeks.
Last month, AA-rated Ningxia Baota Petrochemical raised 800 million yuan, offering to pay 242 basis points more than a coupon paid by AAA-rated Beijing State Owned Asset when it raised 3.5 billion yuan. The gap between two similarly rated five-year bonds in December was 132 basis points