A surge of defaults has shaken China’s $4 trillion corporate bond market, amplifying a growing divide between struggling private firms and a resurgent state sector.
The failures to repay have led investors to favor higher-rated firms over those with lower credit ratings, widening the difference in borrowing costs between the two sets of borrowers.
In theory, that should benefit the world’s second-largest economy, which has logged years of runaway credit growth, and which is still mostly financed by a stretched banking system. Beijing has long sought to foster a strong capital market to better allocate resources. This push has been hampered by the failure to gauge and price risk accurately, and the lack of penalties for failing companies. That is partly because defaults were, until recently, nearly unheard of, as authorities leaned on banks and municipalities to rescue struggling firms.
In practice, however, most of the lower-rated companies are private, and most of the stronger ones enjoy local or central government backing. Buyers have snapped up debt sold by state-backed entities, including local government investment arms that have questionable finances and were near collapse just a year earlier.
“Risk differentiation may seem to have improved but the indiscriminate manner Chinese investors showed in selling bonds issued by private companies, regardless of their fundamentals, suggests this remains an immature market,” said Wang Ying, a Shanghai-based analyst at Fitch Ratings.
After rapid growth in the past decade, China’s $12.7 trillion bond market is the world’s third largest. Debt issued by the central and local governments and the nation’s policy banks makes up about 55% of the total, with tradable certificates issued by largely state-run banks accounting for another 11.5%. Ownership remains dominated by the nation’s state-run banks, insurers and brokerages, with foreign holdings totaling less than 2%.
Last year, 165 bonds worth 157.2 billion yuan ($23.3 billion) defaulted, according to data provider Wind. That was just 0.6% of the entire corporate bond market—but it was more in both volume and value than all such debt in the four years starting 2014, when China saw its first onshore default by a private company.
Private companies, hardest hit by Beijing’s clampdown in recent years on financial risk and an economic slowdown aggravated by trade tensions, accounted for 45 of the 52 defaulting issuers.
Overall borrowing costs have been contained, as a rally in government bonds sent yields on these benchmark securities to two-year lows, pulling yields on riskier bonds lower as well. Yields fall as prices rise.
But while average yields on five-year bonds with an AAA rating have fallen to 3.80% from 5.44% a year earlier, yields on equivalent debt with an AA-minus rating have only dropped to 6.87% from 6.95%.
In September, yields for bonds rated AA-minus hit a 3½-year high of 7.48%. On China’s generous, homegrown credit-ratings scale, such a ranking is commonly viewed as equivalent to “junk.”
The aluminum sector shows some how corporate fortunes have diverged.
Among the bonds that defaulted last year was a 1 billion yuan five-year security issued by Jilin Liyuan Precision Manufacturing Co. , an aluminum product maker from China’s northeastern rust belt. Citing weak cash flows, the company missed an interest payment worth 51.8 million yuan in September. Its bonds fell to just 13.5 cents on the dollar.
Stronger rival China Zhongwang Holdings Ltd. , which is one of the country’s biggest aluminum product manufacturers, has a Chinese credit rating of AA-plus.
While the company has provoked the ire of U.S. industry executives and was the subject of a 2015 short-selling report, its financial performance last year was robust.
Analysts who cover its Hong Kong-listed shares on average expect it to report a 6.9% rise in sales for 2018 and a 2.8% rise in net profit, and to generate positive free cash flow, data compiled by Refinitiv shows.
Yields on a 4-billion-yuan, five-year bond from Zhongwang soared from 4.9% to a record 11.2% in late September. They have since dropped to 7.7%, after President Xi Jinping visited the company in a regional tour meant to demonstrate Beijing’s support for the private sector.
Meanwhile, yields on a seven-year, AAA-rated bond from rival Guangxi Investment Group Co., a state-owned enterprise, hovered between 4% and 5% all of last year.
“When the economy is weakening and companies are running out of cash, investors still find [state-owned enterprises] safer and tend to avoid private firms’ debt as a whole, including better-quality ones like Zhongwang,” said Wu Zhaoyin, chief strategist at AVIC Trust Co., which manages roughly 650 million yuan ($95.7 million) in assets.
Source: The Wall Street Journal
Latest comments