Aviva Looks for Red Flags as $112 Billion Matures: China Credit

Aviva Plc, the U.K.’s largest insurer by assets, is looking out for default red flags as China’s crackdown on shadow banking collides with the heaviest debt repayment schedule in more than two years this month.

Borrowers from the world’s second-largest economy have the equivalent of $112 billion of all types of bonds maturing this month, the most since April 2011, according to data compiled by Bloomberg. Chinese companies account for eight of the 10 financially weakest issuers of U.S. dollar-denominated notes in Asia outside Japan, according to a Standard Chartered Plc report on profitability, leverage and capital structure dated July 5.

“It’s important to look at your portfolio and decide whether the corporates in which you hold positions have any financing vulnerabilities,” said Tim Jagger, a Singapore-based fixed-income portfolio manager at Aviva Investors Asia Pte, a unit of Aviva. “If they are highly dependent on bank debt or trust financing, which is obviously an area that is receiving the authorities’ attention, that’s an obvious red flag.”

Shipbuilder China Rongsheng Heavy Industries Group Holdings Ltd. is seeking financial help from the government, three months after Suntech Power Holdings Co. defaulted on dollar bonds. Slowing economic growth and government efforts to curb risky lending are exacerbating refinancing difficulties amid soaring bond yields. Average dollar debt costs have advanced 66 basis points to 6.18 percent since the end of May, according to JPMorgan Chase & Co. indexes.

Debt Due

An additional $110 billion of notes sold by Chinese borrowers are due by the end of August, data compiled by Bloomberg show. Some 77 percent of bonds maturing this month and 99 percent of notes maturing next month remain outstanding, the data show. The nation’s corporates are the second-most indebted in the region, after Hong Kong, according to Standard Chartered’s report on debt as a percentage of gross domestic product.

China’s industrial companies have suffered a worse deterioration in credit quality since 2007 than state-owned enterprises or high-yield developers, the report shows. Bonds sold by Hidili Industry International Development Ltd., a Sichuan-based coal miner that Standard Chartered included among the 10 weakest dollar-bond issuers in Asia, were quoted at 73.3 cents on the dollar yesterday in Hong Kong, down from 87.3 cents in January, Bloomberg prices show.

“Sectors such as coke and coal mining and steel manufacturing are blighted by huge overcapacity,” said Jagger of Aviva Investors, which managed the equivalent of almost $413 billion as of Dec. 31. “It’s hard to see how the fundamentals of those sectors will improve any time soon.”

Li’s Reforms

China’s State Council, led by Premier Li Keqiang, wants money allocated to transform the structure of the economy to focus more on domestic consumption, according to a statement on its website on July 3. Money-market rates leapt to the highest level in June since at least 2003, as Li tried to rein in so-called shadow lending.

The cash crunch has added to concerns that some companies may be unable to pay off debts as growth cools. China’s benchmark seven-day repurchase rate reached 12.4 percent on June 20, the highest level since May 2006. Chinese benchmark 10-year bonds pay 3.62 percent as of yesterday, 18 basis points more than at the end of May, according to Chinabond indexes.

The economy expanded 7.5 percent last quarter, the slowest in three periods and the longest streak of expansion below 8 percent in at least two decades, as industrial production matched the weakest pace since the 2009 global recession.

Non-Payment Concerns

“The new government is pretty determined in giving up some quantity in terms of the growth rate in order to achieve more quality of sustainable growth,” said Wai Hoong Leong, a Singapore-based portfolio manager at Nikko Asset Management Co. “This restructuring process will probably take time and, if that’s the case, we expect volatility in the Chinese asset market to persist.”

Onshore corporate bankruptcies may be a feature of the short-term pain needed to make structural reforms to the economy, Leong said, adding that a big default in the U.S. dollar-denominated debt market is not likely.

As Li acts on pledges to cut the role of the state in the economy, fiscal spending rose 3 percent last month from a year earlier, down from a 12 percent pace in May, a Finance Ministry report showed this week. The nation is still dealing with the fallout from 17.6 trillion yuan ($2.87 trillion) of stimulus that was plowed into the economy between 2009 and 2010 to insulate it from the global financial crisis.

Spreading Risks

The cost of insuring Chinese sovereign debt against non-payment jumped to a 17-month high of 147 basis points last month, before moderating to 104.5 basis points as of yesterday, according to data provider CMA, which is owned by McGraw-Hill Cos. The yuan advanced 0.05 percent to 6.1350 in Shanghai yesterday, according to the China Foreign Exchange Trade System. The currency was trading at 6.1317 yuan per dollar as of 11:47 a.m.

The cost of 10-year debt for top-rated companies onshore has meanwhile climbed 15 basis points to 5.19 percent since the end of May, the indexes show.

More than 95 percent of bonds due to be repaid this month are denominated in yuan, according to data compiled by Bloomberg. Signs of financial stress onshore will weigh on international bond prices, according to Bharat Shettigar, a senior credit analyst at Standard Chartered.

“If there is a fear of defaults -- even if they’re in the local-currency space -- or if bank non-performing loans start rising, it would be negative for Chinese credits in the dollar space,” he said.

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