UBS Says Market Wants Default as Risks to Pile Up: China Credit

UBS AG’s China securities unit, the leading foreign underwriter of debt sales in the country, says the market wants to see the first onshore bond default to reduce long-term hazards to the financial system.

“Systematic risk will pile up without any default happening,” Bi Xuewen, head of China debt capital markets at UBS Securities Co., said in an interview in Shanghai. “Market participants would like to see a default in China’s bonds. Only after defaults can the overall risk pricing system be normalized.”

Bi, who has led the bond underwriting unit at UBS since 2010, said he doubts there will be a note default in China this year, following previous cases in which local authorities stepped in to avert non-payment. The yield premium on five-year AA- rated corporate bonds over similar-maturity sovereign securities jumped to 404 basis points this week, the highest since May 2012, as concern mounts about trust defaults.

As Premier Li Keqiang drives up money market rates to deleverage the economy, speculation is mounting yields may increase further after Industrial & Commercial Bank of China Ltd. said it won’t bail out a 3 billion yuan ($496 million) trust-bank product it marketed to its clients. China needs credit-market defaults to help encourage better risk pricing, according to Adam McCabe, deputy head of Asian fixed income at Aberdeen Asset Management Plc, which manages $321 billion.

Risk Reminders

“The policy makers need to remind investors from time to time that there are risks they’re taking,” McCabe said in a briefing in Hong Kong on Jan. 21. “A default will help the Chinese market re-profile itself.”

Authorities in the world’s second-biggest economy must balance efforts to sustain economic growth, which slowed in the fourth quarter to 7.7 percent from 7.8 percent in the previous three months, with steps to trim record borrowings without sparking a financial panic.

Liabilities at non-financial companies may rise to more than 150 percent of gross domestic product in 2014, raising default risks, according to Haitong Securities Co., the nation’s second-biggest brokerage. The ratio of 139 percent at the end of 2012 was already the highest among the world’s 10 biggest economies, according to the most recent data.

“If you don’t allow defaults now, risks will rise,” said Zhang Ming, a senior research fellow at the government-backed Chinese Academy of Social Sciences in Beijing. “If you allow defaults, there will be risks but they are controllable. The sooner the default comes, the better for the long-term growth of the Chinese economy.”

Changzhou Wintafone

Changzhou Wintafone Chemical Co., a maker of herbicides and insecticides based in the eastern province of Jiangsu, said this week it has stopped production and couldn’t repay an aggregate bond due in March. Changzhou Qinghong Chemical Co., the note’s guarantor, repaid 36.9 million yuan on its behalf on Jan. 17, according to a statement from Changzhou Wintafone.

As default concerns escalate, the cost of insuring the nation’s debt against non-payment is rising. China’s credit-default swaps increased 19.5 basis points this month to 99.5, set for the biggest monthly gain since June.

The yuan strengthened 2.9 percent last year, and gained 0.05 percent today to close at 6.0488 per dollar.

Bubble Inflating

If defaults come at a time when the currency is no longer appreciating that would spur “massive capital outflows” as Chinese assets would lose their allure for foreign investors, according to Zhang at CASS.

“The bubble is gradually inflating, and sooner or later will burst,” he said. “This year is the best time to squeeze it.”

China Credit Rating Co. lowered the rating for Wuhan Urban Construction Investment & Development Corp., a local-government financing vehicle in the capital of the central Hubei province, from AA to AA-, according to a statement posted on the Chinamoney website on Jan. 6. The Beijing-based rating agency also downgraded Sichuan Coal Industry Group’s rating from A+ to A, according to a statement on Chinamoney on Jan. 13.

The yield on AA- rated five-year corporate bonds has climbed nine basis points this month to 8.34 percent. The rate on the benchmark five-year government bond dropped 14 basis points to 4.32 percent.

Yao Wei, Hong Kong-based China economist at Societe Generale SA, said local governments have helped some companies avert defaults. CHTC Helon Co., a fiber maker that used to be called Shandong Helon Co., repaid 400 million yuan of bonds in April 2012 even as it failed to make loan repayments.

‘Explosive’ Debt

There have been no defaults in China’s publicly traded domestic debt market since the central bank started regulating it in 1997, according to Moody’s Investors Service.

Issuance by LGFVs, which has been “explosive,” is set to rise further this year, according to UBS’s Bi. The National Development & Reform Commission, China’s top planning agency, said Dec. 31 that units facing funding shortfalls for projects will be allowed to sell notes for refinancing.

“The NDRC’s statement is actually a signal to encourage LGFVs to sell bonds,” Bi said. “Previously, the NDRC didn’t allow LGFVs to sell new bonds to roll over their debt and the approval of bond sales was based on new projects.”

UBS led underwrote 27.5 billion yuan of debt onshore in 2013, the most among all the foreign-invested securities firms and banks, according to data compiled by Bloomberg.

Xie Ping, deputy general manager at China Investment Corp., the nation’s sovereign wealth fund, said Jan. 11 China’s local governments won’t default and the central government won’t allow them to go insolvent either, Hexun reported on its website.

While a default in shadow banking would help investors better price risk, it would hurt local funding units and property companies that rely on them for capital, according to Ping An Securities Co.

“A default in the trust product will facilitate the healthy development of the market,” said Ping An’s Shi. “If there is a default, the trust market may shrink and those small LGFVS and small property companies which rely on trust financings will be impacted.”

— With assistance by Judy Chen

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