Look Closer: 57% of China AAA Bond Issuers Have Junk-Like Risks

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China's Junk-Like 'AAA' Bonds
  • Bloomberg Default-Risk Model tracks stock, debt, cash metrics
  • China Railway Materials rated AA+ prior to bond trading halt

So you bought a top-rated yuan bond in China? Take a closer look. It may share characteristics with junk notes in the rest of the world.

About 57 percent of bond issuers listed in China and whose securities are rated AAA in the nation may have default risk consistent with what Bloomberg’s quantitative, independent default-risk model deems a below-investment-grade company. The model tracks metrics including share performance, liabilities and cash flow. It doesn’t take into consideration guarantees or make assumptions about government support, regulations or future earnings.

QuickTake China's Debt Bomb

“We do not rely on onshore ratings from local rating agencies when we make investment decisions,” said Edmund Goh, Kuala Lumpur-based investment manager at Aberdeen Asset Management Plc. “We apply our own internal ratings coming from our own credit research. We are very careful with even AAA rated papers in the onshore China market.”

Investors are pushing for more accurate ratings after at least 10 companies defaulted so far this year, already exceeding the tally for 2015. Dagong Global Credit Rating Co. didn’t cut its grade for China Railway Materials Co. from a second-ranking AA+ until three days after the company suspended trading on its 16.8 billion yuan ($2.6 billion) of notes on April 11 to study debt repayment issues. Bonds rated AA- or lower are considered as Junk in China’s onshore market.

Greater Scrutiny

The National Association of Financial Market Institutional Investors will evaluate rating firms based on feedback given by market players, the 21st Century Business Herald reported May 16.

The Bloomberg risk model data are based on ratings offered by Dagong, China Chengxin International Credit Rating Co., Shanghai Brilliance Credit Rating & Investors Service Co. and China Lianhe Credit Rating Co. Dagong, Chengxin and Lianhe declined to comment on risks with AAA rated bonds.

"It’s normal that Chinese state-owned enterprises are AAA or AA," said Guo Jifeng, vice president at Shanghai Brilliance. Even so, he added, "the possibility that some of the SOE ratings are inflated can’t be excluded."

Dagong said in an April 25 e-mail that its China Railway Materials rating was based on the company’s financial situation and external support, adding that a further adjustment would be made if it weakened further. China Railway Materials paid off 1 billion yuan of bonds due May 17, according to Bloomberg data.

‘Dig Deeper’

Local rating agencies “need to dig deeper into the accounts of state-owned enterprises and companies,” said Woon Khien Chia, a senior portfolio manager in Singapore at Nikko Asset Management Asia Ltd. “The differentiation in credit spreads from sector to sector could be evaluated better."

The China Securities Regulatory Commission, which said in March it had issued warning letters to six rating firms on violations, hasn’t responded to faxed questions seeking comment. An official at the press office of the NAFMII, who wouldn’t be identified, declined to comment on the report that there would be an evaluation of rating firms.

Angang Steel Co. and property developer Gemdale Corp. are among the AAA issuers that the Bloomberg default-risk model deems as having high-yield traits. Angang Steel, rated AAA by Chengxin, reported a 615 million yuan loss in the first quarter, compared with a 19 million yuan net profit a year ago. The state-owned steelmaker canceled a 3 billion yuan bond sale this month, citing weak demand. Two calls to Angang’s board secretary went unanswered Monday.

Angang’s default-risk rises in Bloomberg model as shares slump and short-term debt rises
Angang’s default-risk rises in Bloomberg model as shares slump and short-term debt rises
Source: Bloomberg

Moody’s Investors Service cut its Gemdale rating to Ba2 from Ba1 on April 27, predicting weakened credit metrics over the next 12 to 18 months. In the onshore market, Lianhe rates it AAA. Gemdale hasn’t responded to e-mailed questions seeking comment.

Charlene Chu, a partner at Autonomous Research who made her name warning of the risks from China’s credit binge, said a bailout in the trillions of dollars is needed to tackle the bad-debt burden dragging down the nation’s economy.

“Many local bond ratings are inflated,” said Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co. “Some state-owned companies’ credit quality is bad but they can still get high credit ratings.”

— With assistance by Shuqin Ding, Ling Zeng, Jing Zhao, and Judy Chen

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