China Transitional Pain a Must as Market Matures, Reorient Says

China isn’t facing a financial crisis even as some trust products could default in coming months following the failure of a solar and a real estate company, according to Reorient Financial Markets Ltd.

A “well-behaved” credit-default swap market and gains in information technology and e-commerce stocks in Shanghai this year suggest credit and equity investors are showing “better judgment” about the state of China’s economy, Hong Kong-based strategists Uwe Parpart and David Goldman wrote in a research note today. Reorient Financial is an investment merchant.

“This isn’t a crisis but transitional pain that’s required to move China toward a market-based credit allocation mechanism,” they wrote. “There’s a world of difference between a problem and a crisis.” The strategists couldn’t immediately be reached for further comment by phone.

Investors have doubled bearish bets against developers in the world’s second-largest economy after government officials said March 17 closely-held Zhejiang Xingrun Real Estate Co. didn’t have enough cash to repay 3.5 billion yuan ($565 million) of debt. Shanghai Chaori Solar Energy Science & Technology missed part of an interest payment on a note March 7, the first default in China’s $4.2 trillion onshore bond market.

Media, Pharmaceutical

Credit-default swaps protecting Chinese sovereign bonds against non-payment for five years fell three basis points to 92 as of 11:35 a.m. in Hong Kong, according to data provider CMA. The swaps were at 85 basis points the day before Chaori Solar defaulted, near the lowest in two months.

Media, pharmaceutical and autopart companies are among the top gainers on the Shanghai stock exchange this year, according to Reorient. Losses among banks and insurers reflect a hangover from the 2008 fiscal stimulus that led to “excessive lending and some dicey credit allocation” rather than a breakdown in financing the economy.

Even so, some illiquid trust products may fail in coming months in a “controlled fashion,” the strategists said. Property trusts must repay 634 billion yuan of debt this year, equivalent to the size of Puerto Rico’s economy and up 50 percent from 2013, according to estimates from Haitong Securities Co., the nation’s second-biggest brokerage.

China’s central bank said it didn’t participate in an “emergency meeting” about the collapse of Zhejiang Xingrun yesterday and isn’t involved in dealing with those risks.

Major Themes

Zhejiang Xingrun’s problems are “symptomatic of major themes in the industry including polarization in favor of larger, better funded homebuilders, oversupply in smaller cities and significantly slower growth rates and profit margins,” Fitch Ratings Ltd. said in a March 18 report.

“We believe there’ll be further defaults in this industry as these themes will persist but they’ll be limited to smaller companies like Zhejiang Xingrun,” analysts led by Hong Kong-based Andy Chang wrote. “Most offshore bond issuers will be able to maintain or, in some cases, improve their financial profiles in the next two to three years due to their larger scale and better funding capability.”

Chinese U.S. dollar-denominated high-yield bonds slumped 0.8 percent yesterday, the biggest one-day loss since June 26, according to a Bank of America Merrill Lynch index. Average yields climbed to 9.54 percent, the highest since Sept. 2. The Shanghai Property Index slid 1.4 percent today, after decreasing 0.9 percent yesterday.

“China’s financial system is going through a shakeout,” Parpart and Goldman wrote in the report. “This is long overdue and for the most part, salutary.”

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