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Railway Yield Gap at Six-Month High as Debt Mounts: China Credit

Railway Yield Gap at Six-Month High as Sales Rise
Chinas state-owned railroad is increasing debt sales by 50 percent, driving yield premiums on its bonds to the highest levels in more than six months, as the worlds biggest high-speed network is rolled out. Photographer: Qilai Shen/Bloomberg

China’s state-owned railroad is increasing debt sales by 50 percent, driving yield premiums on its bonds to the highest levels in more than six months, as the world’s biggest high-speed network is rolled out.

The yield on the railway ministry’s 3.88 percent September 2020 bonds exceeded the rate for similar-maturity government notes by 115 basis points yesterday, almost double the 59-point gap when the security began trading in September, according to Chinabond prices. China’s No. 1 corporate debt issuer sold 30 billion yuan ($4.6 billion) of notes in the past two months, more than the combined sales of its counterparts in India and Russia for the whole of 2010, according to data compiled by Bloomberg.

“A lot of investors believe the ministry’s debt is too much,” said Fan Wei, a Beijing-based senior vice president of fixed income at Hong Yuan Securities Co., a unit of the nation’s sovereign wealth fund. “Railway construction is still going to expand a lot and huge debt financing will continue in 2011.”

Spending on China’s railways totaled 1.42 trillion yuan over the last two years, 33 percent more than was invested in the previous five, and the government predicts a further 700 billion yuan will be used to fund construction in 2011. Three-year debt issued by the ministry handed investors a loss of 3.2 percent this year, while similar-maturity notes from OAO Russian Railways delivered a return of 1.3 percent. Indian Railway Finance Corp.’s January 2014 bonds lost 1.1 percent.

U.S. Railroad Defaults

Investors looking into the history of rail expansion have reason to be concerned about China’s growth, which will result in the nation having almost as much high-speed track by the end of next year as the entire rest of the world. Railroads led a collapse in the U.S. corporate bond market in the late 1800s after a flood of defaults on debt sold to extend networks into the American West.

China replaced Minister of Railways Liu Zhijun after the ruling Communist Party said he was under investigation for “severe” disciplinary violations, the official Xinhua News Agency reported Feb. 25. Liu is accused of accepting bribes, according to a Xinhua report on Feb. 12. Zhang Shuguang was removed as deputy chief engineer and placed under investigation for alleged “severe violation of discipline,” Xinhua reported today, citing the ministry.

The ministry’s 3.88 percent bonds due September 2020 yielded 5.1 percent yesterday, the most since the notes were issued in September, according to Chinabond prices. Its 5.6 percent November 2017 debt yielded 4.76 percent. The latter’s premium over similar-maturity government bonds reached 99 basis points on Feb. 24, the biggest gap since July 15.

The 3.6 percent September 2020 bonds sold by Burlington Northern Santa Fe, the railroad bought by Berkshire Hathaway Inc. last year, yielded 4.12 percent yesterday, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

Short-Term Debt

The Chinese railway ministry’s liabilities were equivalent to $198 billion at the end of 2009, with debt levels at 38 percent of assets, the latest data show. The debt-to-asset ratio is higher than the 16 percent for state-owned Russian Railways, and lower than the 82 percent for Indian Railway Finance Corp., the funding arm of India’s rail ministry.

Russian Railways sold the equivalent of $2.2 billion of debt last year, while Indian Railway Finance Corp. issued $1.5 billion, according to data compiled by Bloomberg. China’s railway ministry sold $26.7 billion of notes.

“Investors in Ministry of Railways debt should be worried about its debt situation,” said Li Xuerong, a Shenzhen-based research analyst at CIConsulting, an industry research firm. “The main thing for investors to consider is the risk of not being able to pay its debt in the short term.”

Long-Term Capital

The ministry has 538 billion yuan of bonds maturing by the end of 2036, of which 101 billion is due by the end of this year, according to data compiled by Bloomberg. The proportion of “short-term” bonds increased to 49 percent of the total last year from 18 percent in 2009, according to China International Capital Corp.

“Railways need long-term capital to invest in long-term projects,” said Xu Xiaoqing, the Beijing-based head of fixed-income research at CICC. “Selling short-term bonds is a temporary method until the government injects capital into the railways.”

The ministry, which is supposed to be financially self sufficient, has already received injections of government capital, according to Ji Jiangfan, a CICC fixed-income analyst. Its net assets increased by about 300 billion yuan in the first three quarters of last year, Ji said, which couldn’t have been due to profit alone. Wang Yongping, a spokesman for the ministry in Beijing, couldn’t be reached for comment.


“Aside from a few rail investments of national importance, the Ministry of Railways is self-financing,” said John Scales, transport coordinator for China at the World Bank in Beijing. “Nonetheless, we should remember that the Ministry of Railways is part of the national government and the risk that the national government will allow the ministry to fail is low.”

The government stepped in previously to support the nation’s banks. State asset-management companies in 1999 started buying around 1.4 trillion yuan of bad loans from the nation’s four biggest lenders, a legacy of decades of government-directed lending to unprofitable state-owned enterprises.

Over the next five years China will spend as much as 3.5 trillion yuan on railway construction and 750 billion yuan on rolling stock, according to Macquarie Group Ltd. estimates. Some 2 trillion yuan is being spent to create a 16,000 kilometer high-speed rail network by 2020 and more than 7,000 kilometers of track has already been laid, with a further 6,000 kilometers scheduled to open by the end of next year.

‘Debt Crisis’

The “blind pursuit” of high-speed rail is “highly likely to develop into a debt crisis,” wrote Zhao Jian, a professor of economics at Beijing Jiaotong University, in an April 2010 commentary in the China Daily newspaper.

The Beijing-based railway ministry has sold the equivalent of $339 billion of debt since January 1997, according to data compiled by Bloomberg. Indian Railway Finance Corp. raised $11.4 billion-equivalent since March 1996, while Russian Railways has sold $10.6 billion since December 2004, the data show.

Five-year credit default swaps on Chinese government debt are 7.5 basis points higher this year on concern three interest rate rises in four months may threaten economic growth. The central bank raised reserve requirements for lenders on Feb. 18 just 10 days after boosting rates. The contracts fell half a basis point to 75 basis points yesterday, CMA prices in New York show.

Bond Yield Rises

Credit-default swaps are used to insure debt against default and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The yield on China’s 2.68 percent government bond due in November 2013 rose one basis point to 3.333 percent yesterday, Chinabond prices show. One-year interest-rate swaps, or the fixed cost needed to receive the floating seven-day repurchase rate, fell one basis point to 3.7575 percent as of 9:57 a.m. in Shanghai, according to data compiled by Bloomberg.

The yuan was little changed against the U.S. dollar this morning. Indicative bid prices for the currency were at 6.5728 per dollar as of 9:33 a.m. in Shanghai versus 6.5700 the previous trading day, according to the China Foreign Exchange Trading System. Offer prices were indicated at 6.5730 per dollar, versus 6.5705 the previous day.

Forwards Gain

Twelve-month non-deliverable forwards rose 0.1 percent to 6.412 as of 10:01 a.m. in Shanghai, reflecting bets the currency will strengthen 2.5 percent in one year’s time, according to data compiled by Bloomberg.

China’s railways ministry sold 10 billion yuan of 180-day notes priced to yield 3.92 percent on Feb. 22, just a week after issuing debt with identical terms, according to data compiled by Bloomberg.

“You wouldn’t expect a lot of these projects to repay the principal within 20 years,” said Richard Bullock, a railway consultant to the World Bank office in Beijing. “Particularly when it takes five years to build in the first place.”

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