Dollar Premium Seen Widening From Six-Month High: China Credit

Investors are seeking the highest yield premium in six months to own Chinese dollar-denominated debt and Societe Generale SA predicts further widening as the U.S. economy builds up steam while China’s retools.

The spread over Treasuries surged 71 basis points, or 0.71 percentage point, to 367 basis points in the first quarter, the widest spread since Sept. 27, according to an index compiled by JPMorgan Chase & Co. That ended a five-quarter narrowing run that was the longest on record. The similar gap for Indian debt narrowed 24 basis points, while that for Russian widened by 11 and Brazil’s by 34.

A flood of cash into emerging markets seeking higher returns is slowing as economists forecast U.S. 10-year Treasury yields will rise over the next 12 months and most Federal Reserve officials see bond purchases ending this year. Bond risk in China is rising after Premier Li Keqiang said on March 17 that the government will withdraw the hand of the state and solar panel maker Suntech Power Holdings Co. defaulted on a $541 million convertible note on March 15.

“Higher U.S. yields will reduce the need for insurers to keep buying more credits,” Guy Stear, head of credit research in Hong Kong at Societe Generale SA, said in a phone interview on March 27. “Developers and raw-material companies have low levels of liquidity and I’m afraid we are going to see more bond issuances. That puts us somewhat in a gloomy mood for the coming quarters.”

Bond Rush

The benchmark 10-year Treasury yield climbed nine basis points to 1.85 percent in the first quarter, a second consecutive increase, as Federal Reserve officials debated whether to scale back bond-purchase programs. Stear forecast Chinese credit spreads will widen 75 basis points should Treasury yields climb to 2.75 percent by year end.

The day after Stear spoke to Bloomberg News, the JPMorgan Corporate EMBI China Blended Spread index jumped 33 basis points, the most since 2011, and the Shanghai Composite Index of shares sank 2.8 percent on concern tighter lending rules will hurt bank earnings and economic growth. He recommended buying credit-default swap protection on Hong Kong developers, saying weaker home sales could force companies to sell more debt to boost their cash balances.

The cost to insure China’s debt against non-payment for five years climbed seven basis points in the first quarter to 74 basis points in New York, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. Contracts on bonds of Agile Property Holdings Ltd. cost 659 basis points, down from 674 on Dec. 31, CMA data show. Those for Sun Hung Kai Properties Ltd., Hong Kong’s biggest developer, were unchanged at 135.

Staying Home

Flows into bond funds continued to pivot toward the U.S. and away from European and emerging markets in the week to March 20, according to data published by Cambridge, Massachusetts-based EPFR Global. U.S. funds took 80 percent of the $3.7 billion bond inflows, while commitments to emerging-market debt were the second-lowest in 2013.

Chinese and Hong Kong companies sold a record $21.3 billion of new bonds this year, accounting for 52 percent of issuance by Asian companies, according to data compiled by Bloomberg. Zhongshan, Guangdong-based Agile led $12.5 billion of fund-raising by developers. Its $700 million 8.25 percent perpetual bonds lost 2.1 percent since they were sold on Jan. 18.

Sunac China Holdings Ltd. is marketing $500 million of 2018 dollar bonds at 9.375 percent, after 8.375 percent perpetual debt by fellow developer Beijing Capital Land Ltd. rose on its debut last week.

Pulling Back

Union Investment Privatfonds is trimming its Chinese debt holdings, which were slightly higher than the benchmark against which it gauges performance.

“This market has grown very rapidly in the recent two years from almost zero and the supply pipeline is still very huge, putting pressure on valuations,” said Sergey Dergachev, who helps manage $8.5 billion of emerging-market debt in Frankfurt at Union Investment. “A lot of the underperformance came from the adverse move in Treasuries.”

Union is avoiding China Metallurgical Group and Sinochem International Corp. because their debt-load puts ratings at risk of becoming junk, and CNOOC Ltd. because it may sell more bonds to fund its acquisition of Canadian oil producer Nexen Inc., Dergachev said in an e-mail on March 27.

Sinochem International’s long-term debt has risen to 92 percent of its equity, from 59 percent a year ago. Franshion Properties China Ltd.’s debt is 67 percent of its equity.

Economic Slowdown

Government reports last month showed manufacturing and export indicators in February trailed economists’ estimates, stoking concern an economic rebound is losing traction.

Chinese policy makers set a 7.5 percent growth target for 2013 after the world’s second-largest economy grew 7.8 percent in 2012, the slowest rate since 1999. They are targeting 3.5 percent inflation, down from a goal of 4 percent the previous year, emphasising control on housing costs. Home prices rose 1.1 percent in March from February, the most in two years, according to data released today by SouFun Holdings Ltd., the country’s biggest real estate website owner.

About 17 cities have issued details of property curbs by the end of the first quarter. The capital city of Beijing banned single-person households from buying more than one residence, while Shanghai prohibited banks from giving credit to third-home buyers, the local governments said over the weekend. Lenders in Hong Kong raised mortgage rates after the city’s government doubled stamp duty on property purchases exceeding HK$2 million ($258,000) to damp prices that have tripled since 2004.

Hedge-Fund Bull

The tightening measures will make the market healthier, making property bonds a buy, according to for Rahul Sharma, an emerging-market bond investor at Finisterre Capital LLP, a London-based hedge fund manager with $1.6 billion of assets.

“I’m bullish on the Chinese property market; it’s a capitalist system within a communist country,” Sharma said in a March 27 e-mail interview. “Valuations are still attractive,” supported by strong state ownership in some companies and higher relative yields, he said.

The securities underperformed last quarter due to supply pressure and Finisterre is betting on a rebound as “unrelenting noises” on Europe’s debt crisis diminish, he said. Sharma co-manages a $400 million credit fund which gained 16.4 percent in the past 12 months through February. Its holdings include Franshion, Shimao Property Holdings Ltd. and China SCE Property Holdings Ltd.

Suntech Effect

Yield spreads widened inside China in March. The yield on three-year AA notes rose seven basis points, the most since September, to 5.15 percent, widening the gap over similar-maturity AAA debt to 70 basis points, Chinabond data show. China’s 10-year bond yield fell four basis points in the last quarter to 3.54 percent, Chinabond data show. The yuan rose 0.2 percent in the last three months to 6.2108 per dollar in Shanghai and reached a 19-year high of 6.2077 today.

Investors are wary of the potential for more defaults in China, as well as Europe’s debt crisis, according to Connie Chou, a bond fund manager at Eastspring Securities Investment Trust Co.

“The concern over transparency and corporate governance has resurfaced after the Suntech incident,” Taipei-based Chou said in a March 27 interview. Her firm manages NT$128 billion ($4.3 billion). “It makes a lot of sense for investors to demand higher yields on Chinese dollar bonds.”

Eastspring, the asset management unit of U.K. insurer Prudential Plc, owns a “limited” amount of Chinese dollar bonds and doesn’t plan to add to its holdings, Chou said.

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