PBOC Loan Curbs Widen Corporate Yield Gap Most Since Lehman: China Credit

The premium investors demand to hold China’s corporate bonds rather than sovereign debt widened the most in two years last week on concern that central bank curbs on lending will cause trading in the securities to slow.

The gap between yields on 10-year notes issued by state- controlled companies with top debt ratings and similar-dated government bonds grew 16 basis points to 104 basis points, the biggest increase since Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008, according to Chinabond data. The spread was 81 on Nov. 5, the narrowest since July 2007, and averaged 135 in the past three years.

“As liquidity becomes tighter, brokerages and mutual funds, who trade more frequently than banks and insurers, are selling corporate debt for cash-type securities,” said Jiang Chao, a Shanghai-based analyst at Guotai Junan Securities Co., China’s largest brokerage by revenue. “The yield gap may widen further in the short run in reaction to tightening measures.”

Policy makers ordered lenders to set aside more funds as reserves twice this month and raised interest rates in October for the first time since 2007, seeking to rein in credit growth amid the fastest inflation in two years. That’s leaving finance companies with less to invest in corporate debt after the value of outstanding notes in the interbank market jumped 39 percent in the last 10 months to 3.36 trillion yuan ($506 billion).

Drains Cash

The People’s Bank of China ordered banks to set aside larger reserves for the fifth time this year on Nov. 19, boosting the proportion of deposits that must be set aside by half a percentage point to 18 percent for the nation’s largest lenders. The move will drain about 350 billion yuan from the financial system, Bank of America Merrill Lynch estimates.

“The bond market still needs time to digest the impact of the central bank’s reserve-ratio increase, and we are not optimistic on the direction of the bond market in the short- term,” Citic Securities Co. analysts Wang Mingfeng and Guo Qinmiao wrote in a research note yesterday.

The yield on 10-year government bonds climbed five basis points yesterday to 3.92 percent, while the rate on corporate debt rated AAA increased 6 basis points to 4.97 percent, data from Chinabond, the nation’s largest debt-clearing house, show. The difference between the two has narrowed 34 basis points this year as regulators eased restrictions on corporate-bond ownership, enabling insurers to hold more of the securities and allowing approved overseas banks to invest.

U.S. Yield Gap

Top-rated U.S. corporate bonds with maturities of seven to 10 years yielded 68 basis points more than Treasuries at the end of last week, 10 basis points more than at the start of 2010, according to Bank of America Merrill Lynch’s U.S. Corporate Index. Microsoft Corp.’s 3 percent notes due October 2020 yielded 3.34 percent, 47 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg.

The 5.28 percent bond due April 2020 issued by China Datang Corp., the nation’s second-largest power producer, yielded 4.91 percent yesterday, 107 basis points more than government bonds, according to data from the National Interbank Funding Center. The spread was 86 at the end of October.

Lending curbs reduce liquidity in the corporate-bond market, eroding the attraction of the securities, according to Chen Jianbo, a fixed-income analyst at BOC International (China) Ltd.

“It’s harder to sell corporate bonds for cash than treasury debt when liquidity is becoming tighter,” said Chen, who is based in Beijing. “Banks also reduce purchases of corporate bonds toward year-end to meet annual reporting requirements for capital-adequacy ratios, intensifying liquidity pressure for those bonds.”

Yuan Outlook

Speculation the yuan will strengthen is helping attract overseas investors to China’s bonds, supporting the market, said Tan Weisi, who oversees about 400 million yuan as head of Fortune SGAM Fund Management Co.’s fixed-income arm in Shanghai.

“China’s bond market is much more attractive for overseas than domestic investors, given expected yuan appreciation,” Tan said. “They get at least 6 percent from company bond yields and yuan appreciation is about 5 percent, so we are talking about 10 percent from bond investment. That’s very attractive.”

The yuan has strengthened 2.8 percent to 6.6416 per dollar since a two-year peg ended on June 19 and 12-month non- deliverable forwards reflect bets for a similar gain in the coming year.

Hong Kong-based Industrial & Commercial Bank of China (Asia) Ltd., Standard Chartered Plc and HSBC Holdings Plc have received approvals to invest in China’s interbank bond market, after the central bank relaxed curbs in August. Previously, overseas firms could put funds only into China’s exchange-traded debt using quotas allowed under the Qualified Foreign Institutional Investors program.

Rate Rises

Corporate debt traded on China’s interbank market has handed investors a loss of 1.7 percent this month, trimming gains for the year to 5 percent, Chinabond data show. That compares with a 1 percent loss on government securities.

Bonds slumped in the past month after the central bank raised its benchmark one-year lending and deposit rates by a quarter of a percentage point on Oct. 19, the first increases since 2007, to help contain inflation. Consumer prices rose 4.4 percent from a year earlier in October, the biggest gain since September 2008.

One-year interest-rate swaps, the fixed cost needed to receive the floating seven-day repurchase rate, jumped 21 basis points yesterday to a two-year high of 2.99 percent. Five-year swaps climbed 7 basis points to 3.87 percent, according to data compiled by Bloomberg.

Bond Risk

Contracts insuring bonds of companies with domestic AAA ratings cost 82 basis points, or 82,000 yuan a year per 10 million yuan of debt yesterday, according to quotes from 12 financial institutions compiled by Bloomberg. That’s the lowest in the two weeks that data has been available.

Chinese government dollar bond risk rose, credit-default swaps show. Five-year contracts on the nation’s debt gained 1.2 basis points to 59.8 basis points, according to CMA prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

Moody’s Investors Service raised China’s debt rating to its fourth-highest ranking on Nov. 11, citing the nation’s financial strength and ability to contain losses from a credit boom.

--Belinda Cao. With assistance from Frances Yoon in Seoul and Henry Sanderson in Beijing. Editors: James Regan, Sandy Hendry

To contact Bloomberg News staff for this story: Belinda Cao in Beijing at +86-10-6649-7570 or lcao4@bloomberg.net;

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net;

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