BlackRock Sees Yuan Drop as Wakeup Call for China Debt Hedging

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The yuan’s devaluation is a wakeup call for Chinese companies that rarely hedge overseas debts, according to BlackRock Inc. and Aviva Investors Global Services Ltd.

China’s second-biggest steelmaker Baosteel Group Corp., its largest auto rental company Car Inc. and developer Country Garden Holdings Co. said they’re considering hedging after the Aug. 11 devaluation. Rising demand pushed up the cost of such trades, with the extra interest payments to lenders of yuan in five-year cross-currency swaps jumping 0.16 percentage points in two weeks to 3.18 percent.

“Until recently lots of Chinese companies had regarded the dollar-yuan exchange rate as a one-way bet, therefore there was little need to hedge,” said Tim Jagger, a Singapore-based portfolio manager at Aviva. “Clearly that relationship has changed and companies now need to do more hedging. But hedging costs have also gone up so I expect only more conservative management will do that.”

Companies already face more than $14 billion in extra costs on overseas liabilities after the yuan slid 2.8 percent this month, according to calculations based on Bloomberg data. JPMorgan Chase & Co. forecasts further declines of up to 5 percent in the currency in the next 12 months.

Risk Management

“We will focus more on foreign-exchange rate risk management and will make more use of foreign exchange management tools including spot, forwards and financial derivatives to hedge,” said Chen Ying, vice president in charge of corporate finance at Baosteel. “We will also adjust settlement currencies for imports and exports to reduce foreign-exchange risks.”

Car Inc. is also seeking short-term hedging for interest payment of offshore debt, mostly through forwards, according to its chief financial officer Wilson Li. Country Garden’s investor relations manager Ma Ziling also said the company will closely monitor its forex status in the future.

Costs for forwards or swaps can be as high as 3 percent, according to Gregory Suen, investment director, fixed income at HSBC Global Asset Management Hong Kong Ltd.

“The recent yuan volatility will be a call for Chinese companies with significant foreign debt or imports to start focusing more on hedging,” said Suanjin Tan, portfolio manager for China bonds at BlackRock in Singapore. “Any competent business manager would want to hedge if there is significant mismatch between revenue, cost and liabilities.”

Currency Mismatch

The currency mismatch is the most evident among Chinese developers following restrictive onshore borrowing rules. Their forex assets cover less than 25 percent of foreign liabilities, according to Bloomberg Intelligence.

China Overseas Land & Investment Ltd.’s 63 billion yuan ($9.9 billion) foreign currency liabilities at the end of 2014 were matched by just 8 billion yuan of forex assets, a coverage ratio of 12 percent. The figure is as low as 2 percent at Agile Property Holdings Ltd. and 8 percent at Country Garden, according to a Bloomberg Intelligence report.

“If the yuan continues to depreciate further, Chinese companies with material foreign currency borrowings would see their financial metrics deteriorate,” said Franco Leung, credit analyst at Moody’s Investors Service in Hong Kong.

A better way to manage a weakening yuan is to issue bonds on the mainland as a natural hedge, said HSBC’s Suen. Chinese developers have sold 134.1 billion yuan of notes this quarter, exceeding the total in the previous four quarters.

Geely Automobile Holdings Ltd., founded by billionaire Li Shufu, has been employing some natural hedging strategies including selling foreign-currency debt for overseas parts purchases and when investing in production outside of China, said Lawrence Ang, executive director at the company.

“Without considering the hedging costs, Chinese companies hedging their forex exposure would be positive to their credit profile in general,” said Leung of Moody’s.

— With assistance by Lianting Tu, and Judy Chen

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