24 October 2016
A sustained increase in borrowing costs could threaten China's economy, which is more reliant on cheap credit than ever before. Photo: Bloomberg
A sustained increase in borrowing costs could threaten China's economy, which is more reliant on cheap credit than ever before. Photo: Bloomberg

Investors bearish on Chinese corporate bonds as defaults rise

The unprecedented boom in China’s US$3 trillion corporate bond market is starting to unravel.

Spooked by a fresh wave of defaults at state-owned enterprises, investors in China’s yuan-denominated company notes have driven up yields for nine of the past 10 days and triggered the biggest selloff in onshore junk debt since 2014, Bloomberg reports.

Local issuers have canceled 60.6 billion yuan (US$9.4 billion) of bond sales in April alone, while Standard & Poor’s is cutting its assessment of Chinese firms at a pace unseen since 2003.

While bond yields in China are still well below historical averages, a sustained increase in borrowing costs could threaten an economy that’s more reliant on cheap credit than ever before, the report said.

Listed firms’ ability to service their debt has dropped to the lowest since at least 1992, while analysts are cutting profit forecasts for Shanghai Composite Index companies by the most since the global financial crisis.

“The spreading of credit risks is only at its early stage in China,” said Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co. “Many people have turned bearish.”

China’s leaders face a difficult balancing act.

On one hand, allowing troubled companies to default forces money managers to pay more attention to credit risk and accelerates government efforts to curb overcapacity.

However, investor panic may lead to tighter credit conditions, dealing a blow to President Xi Jinping’s plan to keep the economy growing by at least 6.5 percent over the next five years.

Economic figures for March reveal a growing dependence on debt.

China’s aggregate financing – a broad measure of credit that includes corporate bonds – almost doubled from a year earlier to 2.34 trillion yuan, exceeding all 24 forecasts in a Bloomberg survey as policy makers turned on the taps to support economic growth.

Yet even that wasn’t enough to save the seven Chinese companies that reneged on bond obligations this year.

Three of those were part-owned by China’s government, seen not long ago as a provider of implicit guarantees for bondholders.

Dongbei Special Steel Group Co. on April 13 missed a third payment since its chairman was found dead by hanging last month, while Chinacoal Group Shanxi Huayu Energy Co. failed to make a distribution on April 6.

Baoding Tianwei Group Co., a government-owned maker of electrical transformers that first defaulted a year ago, said on April 14 it may not be able to repay principal and interest on five-year bonds due this month.

State-owned China Railway Materials Co. halted its bond trading on April 11, saying it’s studying debt “repayment issues”.

The reaction has been swift in China’s 18.8 trillion yuan corporate bond market (a figure that excludes certificates of deposit).

The extra yield investors demand to hold seven-year onshore corporate bonds with top ratings over similar-maturity government notes has jumped by 28 basis points from an almost nine-year low in January, to 91 basis points as of Monday.

At least 62 Chinese firms have postponed or scrapped planned note sales this month, six times more than the same period a year earlier.

“To Chinese investors at the moment, default risks are high almost everywhere,” said Shi Lei, the head of fixed-income research at Ping An Securities Co.

The yield premium on corporate bonds will probably rise by 30 to 50 basis points over the next several months, Shi said.

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