China Credit Risk Seen Rising as Slowing Economy Inflates Yields

Updated on
  • Central bank easing may not be enough to lower costs: Haitong
  • Corporate bond yield premium over the sovereign widens

China’s corporate bonds will face increased pressure in 2016, with a rising number of failures and a worsening economy pushing up yields and credit premiums, according to some of the nation’s top brokerages.

“Default risks of corporate notes will certainly rise in 2016, and investors’ risk preference will turn lower compared with the past couple of years,” analysts led by Shanghai-based Chen Kang at SWS Research Co., a unit of brokerage Shenwan Hongyuan Group Co., wrote in a note on Monday.

While the nation saw its first-ever onshore bond default last year, there have already been seven failures in 2015. Sichuan Shengda Group Ltd. was the latest, joining companies including China Shanshui Cement Group Ltd. and state-owned Sinosteel Co. This comes even after six interest-rate cuts by the central bank in the past year.

The yield premium on five-year AA- rated debentures over the sovereign widened 19 basis points last month, the most in a year, after touching a seven-year low of 176 basis points in early November. The difference was at 189 basis points on Friday. China’s gradings of AA- or below are equivalent to non-investment ratings globally, according to Haitong Securities Co.

“As credit events are increasing and bad loans rising due to an economic downturn, even central bank easing may not be enough to lower some companies’ financing costs,” Haitong analysts led by Jiang Chao wrote in a report on Monday. The brokerage predicts up to two interest-rate cuts next year and five reductions in bank reserve ratios.

Policy Easing

Premier Li Keqiang is facing a balancing act as he eases fiscal policy to meet a target of 6.5 percent annual economic growth for the next five years, while reining in a debt pile that is estimated to be already more than twice the size of the world’s second-largest economy. The pressure to boost expansion has prompted regional authorities to turn back to local-government financing vehicles, which were seen as a dying breed not so long ago for being opaque and indulging in unrestrained borrowings.

Companies rated AA or even AA+ will show bigger difference in risk pricing next year, SWS’s analysts wrote in Monday’s note. In the next two to three years, corporate notes’ pricing will increasingly reflect credit risks, they added. Chinese authorities will set a timetable for cleaning up so-called “zombie companies,” according to a Nov. 24 Economic Information Daily report.

“Default risks will continue brewing next year,” China International Capital Corp. analysts including Ji Jiangfan wrote in a note last week. “Excessively low yield premiums for low-grades will be reassessed to reflect the real risks.”

— With assistance by Helen Sun

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