PBOC Singling Out Industries Fuels Nomura Anxiety: China Credit

The singling out of three debt types most at risk by the People’s Bank of China has prompted Nomura Holdings Inc. to warn that rising borrowing costs will make it even harder to avoid a default by these issuers.

The PBOC will enhance monitoring of local government financing vehicles, industries with overcapacity and property developers to prevent default risks from spreading, according to its fourth-quarter policy report issued on Feb. 8. Jinzhou Economic Technology Zone Development Group Co., an LGFV in Liaoning province, sold new seven-year bonds at 9.1 percent in January, while Guangxi Nonferrous Metal Group Co. issued nine-month bills at 8.5 percent. That’s almost twice as high as the yield on 2021 government debt.

“The three industries singled out by the PBOC are the most likely to have defaults this year,” Zhang Zhiwei, Nomura’s Hong Kong-based chief China economist, said in a Feb. 10 e-mail interview. “Individual LGFV defaults will happen this year, but are unlikely to lead to a systemic financial crisis as the central government is expected to intervene.”

The cost of potential bailouts is escalating, with an official audit estimating regional liabilities alone jumped 67 percent from the end of 2010 to 17.9 trillion yuan ($2.95 trillion) as of June 30 last year. The PBOC has allowed money-market rates to surge to deleverage debt in the world’s second-largest economy that the Chinese Academy of Social Sciences estimates accounts for 215 percent of gross domestic product.

Crisis Levels

The buildup has evoked comparisons to Japan’s debt surge before its lost decade and to that in Thailand ahead of Asia’s financial crisis. Japan’s credit-to-GDP ratio rose to 176 percent in 1990 from 127 percent in 1980, JPMorgan Chase & Co. said in a July report.

The first credit events in China will probably occur in industries with excess capacity because demand is weak and the government is seeking to curb expansion, said Zhang. China has ordered more than 1,400 companies in 19 industries such as steel, ferroalloys and cement to slim down as part of a drive to refocus the economy on domestic demand and cut air pollution.

The average spot price for steel rebar, mostly used in construction, dropped 3.2 percent this year to 3,387 yuan a ton yesterday, the lowest since July 4, according to metals researcher Beijing Antaike Information Development Co. About 28 percent of steel companies had losses in the first 11 month of last year, according to the China Iron & Steel Association.

Steel, Coal

Nanjing Iron & Steel Co., partly owned by Chinese billionaire Guo Guangchang, said last month its 2018 bonds may stop trading because it could report a second year of losses. The yield on the notes has soared 207 basis points this year to 10.71 percent today. Ningxia Xinri Hengli Steel Wire Co., a Chinese maker of wire and rope, said on Jan. 30 a Shanghai court froze the stake held by its largest shareholder Xiao Jiashou due to a loan dispute.

In the coal industry, global oversupply will prevent a significant price recovery this year, Moody’s Investors Service said in its 2014 outlook last month, explaining its negative outlook on the industry in Asia. It estimates benchmark Newcastle Thermal Coal prices will range between $80 and $85 a ton, after a 35 percent drop in the past two years to $77.35.

Structural Surplus

“In many commodities, especially steel and coal, there is a structural surplus,” Gary Lau, managing director for corporate finance at Moody’s, told a press briefing in Hong Kong on Jan. 23.

An investment product created by Jilin Province Trust Co. and backed by a loan to coal company Shanxi Liansheng Energy failed to repay investors when some tranches matured, Shanghai Securities News reported today, without citing anyone. It said the fourth batch of the product, which raised 972.7 million yuan from China Construction Bank clients, matured on Feb. 7 and CCB sent an announcement from Jilin Trust saying the funds can’t be returned as the company is being restructured.

China’s central bank signaled in the Feb. 8 report that volatility in money-market interest rates will persist until debt is tamed. The seven-day repurchase rate jumped to a record 10.77 percent on June 20 and averaged 4.09 percent last year, from 3.50 percent in 2012. The benchmark was 5.21 percent today.

Investors have been favoring safer bonds this year. The yield on the seven-year government bond has fallen 18 basis points to 4.41 percent yesterday. The yield on similar-maturity AA corporate debt, the most common rating for LGFVs, climbed 2 basis points to 7.64 percent. The spread widened to 323 basis points, the most in two years. The yuan, which touched the year’s low of 6.0646 per dollar on Feb. 7, was little changed at 6.0619 as of 2:53 p.m. in Shanghai.

No Defaults

There have been no defaults in China’s publicly traded local debt since the central bank started regulating it in 1997, according to Moody’s. China Credit Trust Co. reached an agreement last month to repay investors in a high-yield product after the coal mine that received the funds collapsed.

Huangshi Cihu High-Tech Development Co., an LGFV, sold 700 million yuan of seven-year notes at 9.3 percent in January, according to data compiled by Bloomberg. The highly centralized system governing local authorities in China results in a significant level of supervision, Moody’s said in a report yesterday. The likely intervention of the central government is an important credit support, it added.

“LGFVs are relatively safe because the government will help, and they can set up new mechanisms to solve the problem,” said Zhang Yixin, a Shanghai-based bond analyst at Tebon Securities Co. “Real-estate developers and companies in overcapacity industries are more dangerous,” she added.

Property Bonds

Dollar bonds maturing in March 2018 of Glorious Property Holdings Ltd. reached 19.91 percent on Feb. 10, from as low as 11.19 percent in May last year. The developer with projects in 12 Chinese cities said Feb. 5 its chief executive officer and chief financial officer resigned less than one month after shareholders rejected an offer by Chinese billionaire Zhang Zhirong to take the developer private.

Centaline Property Agency Ltd., China’s biggest real-estate brokerage, said there was oversupply last year in urban centers other than the nation’s four biggest cities, even as home prices in December recorded 2013’s biggest increase. Surging land prices have driven up expenses for developers, with 12 out of 30 companies in second-tier and third-tier cities surveyed by Standard Chartered Plc. saying it has become harder to get financing, according to a Jan. 27 report from the bank.

“If credit risks spread, the PBOC will be forced to loosen policy,” Liu Dongliang, a Shenzhen-based analyst at China Merchants Bank Co., said in a phone interview yesterday. “Nobody wants it, but a default will be no surprise as risks are mounting.”

— With assistance by Helen Sun

Before it's here, it's on the Bloomberg Terminal.