(Bloomberg) -- Cash-strapped Chinese borrowers are losing another funding avenue, as default jitters rock a market that relies on quasi guarantees from banks for repayment. 

Sales of China dollar notes carrying a so-called standby letter of credit, effectively a lender’s pledge to repay if the issuer can’t, slumped 90% to $1.04 billion so far this year from the previous year, according to Bloomberg-compiled data. This outpaced a 52% drop in China dollar bond sales to $52.2 billion for the same period, the data showed. 

With the nation’s developers going through a fresh round of crises and even large builders defaulting, banks are reluctant to provide such pledges. Investors also have doubts over the structure, which falls short of being an explicit repayment guarantee. That’s upended a market that helped lower-rated companies, including local government financing vehicles, raise a record $10.3 billion in 2022.

“At the end of the day, the question for the standby letter of credit providers is: are they being compensated sufficiently to take on the risk of default of the issuer?” said Charles Chang, Greater China country lead for corporates at S&P Global Ratings.

The pledge to repay was tested this year, when Chinese developer Sino-Ocean Group Holding Ltd. missed payment on its debt. While the company said it would suspend payments for all its offshore bonds, it made a $3.8 million interest payment due Oct. 26 for its 2025 dollar security backed by China Zheshang Bank Co.

The standby letter of credit uses the company’s assets as collateral and the payment reflects solutions to the group’s debt “based on the different rights of different stakeholders,” Sino-Ocean said in a filing in October. 

Sino-Ocean didn’t respond to a Bloomberg request for comment. 

In 2019, there were two other high profile tests —China Minsheng Investment Group Corp. and Tewoo Group Co. —which were honored by China Construction Bank Corp. and Industrial and Commercial Bank of China Ltd., respectively. 

When evaluating the credit risks of such bonds, Moody’s Investors Service relies more on the creditworthiness of the banks providing the standby letters instead of the issuers, said Kan Leung, an analyst at the ratings firm. 

Increasingly, regional banks are backing such debt, raising questions on the strength of recent guarantees. For example, Zheshang Bank, a bank in the southeast part of China, which provided the standby letter for Sino-Ocean, also offered similar backing for a dollar bond sold by Chinese developer Greentown China Holdings Ltd. last year. Out of the 122 SBLC-backed dollar bonds issued in 2022, Zheshang Bank provided standby letters for 18 of them, Bloomberg-compiled data shows. 

--With assistance from Emma Dong.

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