Resource Grab Costs to Rise as Yields Hit ’08 High: China Credit

Bond Yields at Three-Year High Amid Resource Grab
A bust of Mao Zedong, former leader of China, sits on display in the lobby of China Development Bank Corp.'s office in Beijing. China Development Bank lent $134.6 billion in foreign currency last year, the most of any Chinese bank. Photographer: Nelson Ching/Bloomberg

The highest funding costs since 2008 may make it more expensive for China’s state banks to lend to commodity producing nations, as the world’s fastest-growing major economy tries to secure natural resources to fuel growth.

Five-year borrowing costs for the so-called policy banks surged 70 basis points to 4.6 percent this year and touched a three-year high of 4.68 percent on Aug. 4, Chinabond prices show. Top-rated Indian lenders pay 9.45 percent on their five-year debt, compared with 8.94 percent at the end of 2010, data compiled by Bloomberg show.

The government relies on China Development Bank Corp. and Export-Import Bank of China to lend to resource-rich nations such as Brazil, Kazakhstan and Venezuela in exchange for commodity and energy supplies. Borrowing costs surged after the central bank raised interest rates to control inflation and lenders increased provisions against loans for local governments. The value of banks’ dollar loans are falling as the yuan strengthened 3.3 percent against the currency in 2011.

“Foreign exchange and rising funding costs are working against them and yields are probably decreasing on loans, especially if they are U.S. dollar,” said Mike Werner, an analyst at Sanford C. Bernstein & Co. in Hong Kong. While the profits of policy banks will “be hurt in the current environment,” their lending supports government policies and is “still beneficial to the overall economy,” he said.

‘Overseas Settlement’

Export-Import Bank of China will lend more overseas using the yuan rather than the U.S. dollar, Liu Liange, a vice president at the bank, said in an interview yesterday.

“It’s not only a problem Exim bank has, it’s also a problem greatly affecting Chinese companies with overseas business,” he said at the World Economic Forum in Dalian. “Right now we are thinking of ways to solve this, including using yuan for overseas settlement. This is something we’ll be doing in the future.”

China Development Bank, China’s second-largest bond issuer after the Finance Ministry, sold 18 billion yuan ($2.8 billion) of 10-year notes at a coupon rate of 4.87 percent on Sept. 5, Bloomberg data show. That compares with the 3.74 percent rate on 20 billion yuan of similar-maturity securities issued in April last year.

The Beijing-based bank reported currency-related losses of 18.98 billion yuan in 2010, versus gains of 862 million yuan in 2009, according to its annual report released in June. Each one percentage point appreciation in the yuan causes a foreign-exchange loss of 5.54 billion yuan for the lender, it said. The loans are counted as assets on the banks’ balance sheets and a rising yuan diminishes the value of foreign-currency lending.

Oil Shipments

China Development Bank lent $134.6 billion in foreign currency last year, the most of any Chinese bank, Chairman Chen Yuan said in May. The lender signed a $2 billion loan with Ecuador in June and completed a $20.6 billion oil-for-loans agreement with Venezuela in August last year.

Venezuela’s oil shipments to China are approaching 400,000 barrels a day, President Hugo Chavez said in comments carried by state television earlier this week after he and Chen met in Caracas.

The lender has sold 715 billion yuan of local-currency bonds in China this year, compared with 850 billion yuan in 2010, according to its annual report and Bloomberg data.

“China Development Bank’s cost of bonds has continually increased, which will impact their cost of capital,” said Fan Wei, a Beijing-based fixed-income analyst at Hongyuan Securities Co. “It will have a negative impact on their profit and on their new loans and the loan rate will be higher.”

China Exim Bank

Funding costs are also rising for Export-Import Bank of China, which has sold 281 billion yuan of bonds this year, Bloomberg data show, compared with 189 billion yuan in 2010, according to its annual report.

The Beijing-based policy lender known as China Exim Bank sold 20 billion yuan of five-year bonds on Aug. 9 at a coupon of 4.37 percent, versus 3.98 percent on 26.73 billion yuan of similarly dated notes in December, Bloomberg data show.

The bank approved 436.4 billion yuan of lending last year, and total outstanding loans stood at 874.7 billion yuan as of 2010, China Exim Bank said in its annual report. That’s more than 14 times the amount lent by Export-Import Bank of India with $9.6 billion of outstanding loans, while Export-Import Bank of Korea has $35 billion, Bloomberg data show.

Latin America, Africa

China Exim Bank had outstanding loans in Latin America of 50 billion yuan at the end of August and 200 billion yuan in Africa, its Vice President Zhu Xinqiang said in an interview in Beijing on Sept. 13.

Among them is a 9.85 billion-shilling ($103.6 million) loan to Kenya agreed in June. The East African nation is rated B+ by Standard & Poor’s, four levels below investment grade.

“There are 53 countries and we have business in 45 countries” in Africa, Zhu said. The lender invites “Chinese insurance companies to join us,” he added, when asked how it controls credit risks.

The extra yield investors demand to own five-year bonds sold by policy banks instead of similar-maturity government debt has widened to 69.6 basis points, or 0.696 percentage point, from 36 basis points at the end of last year, according to Chinabond. The spread reached 84.9 on July 20, the widest since June 2008.

Five-year credit-default swaps on Export-Import Bank of China increased 143.4 basis points this year to 265.9 basis points, while contracts on China Development Bank rose 172.4 to 294.8, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Local Government Loans

The policy lenders, set up to support the government’s economic development goals, are also “major providers” of loans to local government finance units, according to a central bank report issued on June 1. S&P estimates that as much as 30 percent of China’s lending to local governments may go sour, while Moody’s Investors Service said on July 5 that regional authorities may owe about 14 trillion yuan.

Werner of Sanford C. Bernstein estimates China’s policy banks have 2.6 trillion yuan of loans outstanding to local government financing vehicles, according to a July 4 report.

The cost to protect China’s sovereign debt against default jumped the most in two years in August and was last at 130.3 basis points as of Sept. 14, CMA prices show. 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 its debt agreements.

Fighting Inflation

The People’s Bank of China raised the benchmark one-year lending rate five times since the middle of October 2010, with the latest increase in July lifting borrowing costs to 6.56 percent. Inflation, which slowed to 6.2 percent in August from a three-year high of 6.5 percent the previous month, must be stemmed even with the threat of a global slowdown, Premier Wen Jiabao said on Sept. 14.

The yield on China’s benchmark 10-year bonds rose 16 basis points to 4.05 percent this quarter. That’s 200 basis points more than the rate for similar-maturity U.S. Treasuries.

The yuan is the only currency among the biggest emerging nations to strengthen against the dollar this quarter. Known as the renminbi in Chinese, the yuan has climbed 1.3 percent versus the dollar since June 30, while India’s rupee dropped 6 percent and Russia’s ruble and the Brazilian real each slumped 8.4 percent.

‘Financial Strength’

China’s economy grew 9.5 percent in the second quarter, the slowest pace since 2009, as faltering growth in developed nations cooled demand for the country’s exports. Expansion will slow to 8.7 percent in 2012, according to the median estimate of economists surveyed by Bloomberg. Oil and gas was the company’s biggest import in July, followed by pulp, data compiled by Bloomberg show.

The U.S. economy will grow 2.2 percent next year, while Europe will expand 1.15 percent, the surveys show.

“China can easily finance any overseas trade and investment it wishes to undertake,” David Marshall, an analyst at research firm CreditSights Inc. in Singapore, said by e-mail. “It is even better able to do this now as China’s relative economic and financial strength has grown enormously” since the global financial crisis following the 2008 collapse of Lehman Brothers Holdings Inc., he said.

— With assistance by Henry Sanderson

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