China’s credit market just suffered its worst selloff in two years as a major conglomerate’s plunge into distress tests the assumption that government ties can protect state-owned firms from financial peril.

In just a few days, Zhuhai Huafa Group Co. called that view into question. The conglomerate, wholly owned by local governments in the southern province of Guangdong, missed payments on two trust products and asked to extend some bank loans, people familiar with the matter said last Monday.

By Friday, unease was mounting as investors came to terms with the implications in a country where missed debt payments by state-owned firms had become rare. Over the two days through Monday, money managers pushed the average yield they demand to hold benchmark Chinese corporate bonds up 10.3 basis points, the worst two-day stretch since October 2024. Those rates on three-year yuan notes with the same local AAA ratings as Huafa were little changed Tuesday morning, traders said.

The crisis at Huafa, which has helped build landmarks such as the 330-meter tall Zhuhai Tower skyscraper, is spotlighting risks among Chinese state-owned firms reliant on implicit government support as a yearslong property downturn and slowing economic growth hurt profitability. Its offshore bonds tumbled to distressed levels as low as about 54% of face value last week, as concern mounted over its 413 billion yuan ($62 billion) of interest-bearing liabilities.

“Local government financing vehicles and some state-owned firms with weak standalone credit profiles are just a ticking time bomb,” said Zerlina Zeng, head of Asia credit strategy at Creditsights Singapore.

The shock from Huafa even briefly spilled beyond the onshore credit market. Chinese high-yield dollar notes suffered their worst week in about a year last week. In the local sovereign debt market, 30-year government bond futures posted their biggest daily drop since March on Friday, with traders citing Huafa as a drag on sentiment across markets.

The conglomerate’s stumble stands out, after accommodative monetary policy in recent years and an unprecedented government push to contain debt risks tied to local authorities helped avoid such outcomes. It also raises concerns given Huafa’s home base of Guangdong, which has China’s biggest provincial economy.

“Almost every major financial institution I know holds Huafa bonds, especially state-owned institutions,” according to Li Huan, co-founder of asset manager Forest Capital Hong Kong Ltd.

To some investors, the situation recalls refinancing stress that swept through China’s coal sector after a surprise default by a state-run miner roiled markets in late 2020. The miner ultimately made full payment on its bonds months later as local authorities moved to restore market confidence.

Huafa’s offshore yuan-denominated securities due in 2027 have pared some of their earlier losses, recovering to about 63% of face value. That comes after news that it had repaid one of its trust products and that its property arm made good on payments due Monday on a yuan note.

Still, uncertainty persists over the company’s liabilities in the longer-term, and more broadly over the extent to which China will support its debt-laden state-owned firms.

If Huafa continues to repay its public bonds and makes progress on asset monetization, the concerns could prove to be a temporary liquidity crunch contained by local authorities, according to a research note by China Zheshang Bank Co. But bond extensions or even potential restructurings could trigger a broader reassessment of the state-owned sector, the note said.

Huafa is about 93.5% owned by Zhuhai’s State-Owned Assets Supervision and Administration Commission, with Guangdong’s provincial finance department owning the remainder. The company had about 765 billion yuan in total assets as of March.

The conglomerate, which derived about half of its revenue from property development and urban operations last year while also running businesses spanning financial services and technology, had blamed the property downturn as the main reason for its profitability swings.

A few days ago, its real estate arm reported a 6.44 billion yuan net loss in the first nine months of this year.

Huafa was placed last week on rating watch negative by Fitch Ratings, which scores it at BBB, toward the lower end of investment grade. The step signals increased possibility of a downgrade.

Fitch cited the company’s “weakening debt-service coverage, approaching near-term debt maturities and widening issuer bond spreads amidst unconfirmed market rumors of potential debt-maturity extensions.”