Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

There's a mixed blessing in Moody's Investors Service's decision to change China's rating outlook to negative. It could bring a handful of companies into junk territory, which is where they should have been in the first place.

Relative Stability
Investment-grade bonds from China performed better than high-yield notes. But some of them shouldn't be there.
Source: Bloomberg; Bank of America Merrill Lynch

That's because if a sovereign downgrade does result, Moody's is likely to move most of the scores of the Chinese companies it rates down as well. At least 16 are at Baa3, the lowest investment grade, so they're already teetering on the edge. About half of those, arguably, would never have gotten a score above speculative in the first place were it not for their state ties. On a standalone basis, the companies are too leveraged to be rated investment grade themselves:

Higher Values
Some Chinese companies have enjoyed lower yields than their debt levels merit
Sources: Bloomberg; Moody's Investors Service
* Rating reflects guarantee from Sinoguarantee

Moody's has already put one of them -- financial services provider BL Capital Holdings -- on review for downgrade after Export-Import Bank of China's stake was reduced to 7 percent from 9.75 percent via a series of capital injections the state-owned lender didn't participate in. Among companies that have issued bonds offshore, developers Poly Real Estate, Yuexiu Property and Sino-Ocean Land, along with steelmaker China Metallurgical Group and Bright Food, have been awarded investment-grade ratings based in large part upon expected sovereign support.

While those expectations have never really been tested, the looming risk now is that as China tries to stem record capital outflows it may not be so willing to bail out the scores of companies with government links. As Societe Generale's cross-asset research team noted in a report last month: ``In almost all countries, barring Singapore, government plus corporate debt is a lower percentage of GDP than in the euro area and the U.S., but in places such as Hong Kong, China, Korea and Thailand, corporate debt is massive relative to government debt.''

If Moody's does downgrade China to A1 from Aa3, a slew of fallen angels is sure to follow. Investors in those companies' bonds can expect some short-term pain as prices adjust to reflect their new junk status. But that's a good thing. They never deserved to inhabit those upper echelons to begin with.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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