China Bond Bulls Focus on Stimulus Outlook Amid Default Drumbeat

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Defaults and debt rating cuts aren’t putting off bulls on China’s dollar bonds.

Kaisa Group Holdings Ltd. became China’s first builder to renege on U.S. currency notes last week and Moody’s Investors Service cut Glorious Property Holdings Ltd.’s rating to Ca, one step from a grade typically signaling default. Yet Nomura Holdings Inc. sees state support for cash-strapped firms making the nation’s dollar securities Asia’s best gainers. Aberdeen Asset Management Plc says capital controls make China most able to withstand any U.S. Federal Reserve rate increases.

Bond and stock markets are showing signs of confidence in China’s ability to prevent contagion. While credit concerns have slowed returns on Chinese bonds, they are still up 3.2 percent this year, third among major Asian markets after Indonesia’s 5.4 percent and Singapore’s 3.3 percent, Bank of America Merrill Lynch indexes show. Stock gauges climbed to a seven-year high last week after the central bank cut reserve requirements by the most since the global financial crisis.

“Despite Kaisa’s recent default, dollar bonds from Chinese issuers are likely to outperform other Asian dollar-denominated notes given the recent monetary easing by the PBOC to boost growth,” said Gaurav Singhal, Hong Kong-based credit analyst at Nomura. “Chinese credits will also be less vulnerable to Fed rate hikes as a result of the country’s current account surplus and stable currency.”

Unprecedented Debt

Premier Li Keqiang has pledged to prevent a systematic fallout while allowing individual cases of financial risk. There’s never been more at stake after global investors bought a record $194.2 billion of dollar bonds issued by Chinese companies last year, according to data compiled by Bloomberg.

“Weaker companies should be allowed to fail and we should expect a lot of defaults in China,” said Andy Seaman, portfolio manager in London at Stratton Street Capital LLP. “But it’s not particularly bad news for China as it’s part of the modernization of its financial system.”

Li’s steps to open the cooling economy to market forces and trim the responsibilities of the government require a shift toward greater tolerance of corporate failures. Baoding Tianwei Group Co. marked the nation’s first default on domestic bonds by a state-owned firm last week.

China Construction Bank Corp. provided loans to Tianwei after central bank coordination, local news outlet Caixin reported over the weekend, citing an unidentified person.

Market Calm

Five calls to the general office of Tianwei went unanswered Monday, and three calls to the company’s new energy unit general office also went unanswered. An e-mail seeking comment sent to the e-mail address listed on the company website bounced. A Beijing-based press officer at CCB declined to comment on the Caixin report. There was no immediate reply from the PBOC to faxed questions about the report.

The broader debt market has remained calm amid the defaults. The five-year AAA yield fell 17 basis points last week to 4.44 percent, while the similar AA- yield fell 22 basis points to 5.89 percent, reflecting easier monetary conditions. Credit-default swaps insuring the nation’s notes against nonpayment dropped 2.3 points last week to 90.7 basis points. The yuan gained for a second week, closing Friday at 6.1950 per dollar.

“Offshore investors are able to look past some individual defaults and focus on a bigger China space, which is being supported by the PBOC easing,” said Owen Gallimore, the head of credit strategy for Asia at Australia & New Zealand Banking Group Ltd. in Singapore.

‘Further Rally’

China’s interest-rate swaps declined to the lowest level since 2012 earlier Monday on speculation the central bank will keep borrowing costs low amid the mounting debt pressure.

“While China property bonds already stand out among Asian credits, there is much room for further rally,” Gordon Ip, senior fund manager at Value Partners Ltd., wrote in a note Monday.

The country’s corporate bonds in dollars are also set to weather any Fed interest rate increases because they’re held mostly by Asian investors who tend not to chase rising rates in the U.S., according to Thu-Ha Chow, head of Asian credit in Singapore at Aberdeen Asset. The company had $504.1 billion in assets under management as of Dec. 31.

“Historically there is less correlation between Chinese bonds and U.S. dollar rates because much of the Chinese bonds are held by Asian investors,” Chow said. “This is true especially for high-yield bonds from China, also for some investment grade names.”

‘Less Sensitive’

According to research from Nomura, 85 percent of Chinese property bonds are sold to Asian investors, compared with 65 percent for Asian credits overall. At Shimao Property Holdings Ltd.’s $800 sale of notes in February, some 73 percent of the securities went to Asian investors, according to a person familiar with the matter at the time. Investors in the region took 92 percent of a $300 million tap of the debentures in March, another person familiar said last month.

“The high-yield space in general will be less affected by the Fed hike, with China high-yield possibly even to a lesser extent because those bonds are mostly held within Asia,” said Harsh Agarwal, head of Asia credit research at Deutsche Bank AG.

Investors globally are looking for a safe havens in preparation for any Fed tightening with memories still fresh from the so-called taper tantrum of 2013 when investors fled riskier investments in emerging markets. While China’s currency reserves have shrunk for the past five months, they are still $3.7 trillion.

“The external balances including current account surplus and foreign exchange movement point to the fact that China is much more insulated,” said Andre de Silva, Head of Global EM Rates Research for HSBC Holdings Plc in Hong Kong. “China is one of those few emerging-market countries that are far less sensitive to whether the Fed raises rates.”

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