Morgan Stanley Sees More China Defaults as Cash Squeeze Tightens

More Chinese companies are heading toward default as higher funding costs and slowing growth weigh on existing debt commitments, according to Morgan Stanley.

“The pressures are now on for the corporate default rate to be moving higher,” said Viktor Hjort, the Hong Kong-based head of Asia fixed-income research at the U.S. lender. “Any economy that generates defaults usually needs three things, leveraged balance sheets, sluggish growth and tighter financial conditions. China ticks all three boxes.”

Chinese issuers pay an average 6.22 percent for dollar-denominated securities, after yields touched 6.39 percent on March 20, the highest since September, JPMorgan Chase & Co. indexes show. Top-rated companies pay an average 6.05 percent for 10-year notes onshore, the most in a month and poised for the biggest monthly increase since November, according to Chinabond indexes.

Corporate borrowing spiraled during the global credit crisis, as the Chinese government encouraged banks to lend to support the economy. Financial institutions are now clamping down on non-performing loans and curbing new lending, pushing up the cost of servicing this debt as the nation’s economy slows. A preliminary gauge of manufacturing missed estimates this week, suggesting factory output weakened for a fifth straight month in March.

Solar-cell maker Shanghai Chaori Solar Energy Science & Technology Co. became the first company in China to default on its onshore notes earlier this month.

Credit Caution

“Access to credit has become increasingly tight,” Hjort said in an interview yesterday. “That’s what’s starting to create tensions in terms of credit risk in China, creating the basis to expect default rates will go up, and is the main reason why one needs to be cautious.”

China’s economic growth is expected to slow to 7.4 percent this year, according to the median estimate of 55 analysts surveyed by Bloomberg News. Total lending by Agricultural Bank of China Ltd., the nation’s third-largest, grew 12 percent in 2013, down from 14 percent a year earlier, according to annual results published yesterday.

The seven-day repurchase rate, a gauge of funding availability in the interbank market, climbed 96 basis points, the most since Jan. 20, to 4.84 percent today, National Interbank Funding Center data show. The measure is rising for an 11th straight day, the longest streak in seven years.

The cost of insuring Asia-Pacific corporate and sovereign bonds from default rose, according to credit-default swaps traders.

Risk Rises

The Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan climbed 2 basis points to 132 basis points as of 8:28 a.m. in Hong Kong, Australia & New Zealand Banking Group Ltd. prices show. The gauge is set for its biggest one-day rise since March 20 when the new series of the index began trading, according to data provider CMA.

The Markit iTraxx Australia index added 1 basis point to 103.5 as of 11:32 a.m. in Sydney, according to Westpac Banking Corp. The measure is also on track for its highest close since March 20, according to CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the private market. The Markit iTraxx Japan index advanced 0.5 of a basis point to 86.3 as of 9:40 a.m. in Tokyo, Citigroup Inc. prices show.

Credit-default swap indexes are benchmarks for insuring bonds against default and traders use them to speculate on credit quality. A drop signals improving perceptions of creditworthiness, while an increase suggests the opposite.

The swap contracts pay the buyer face value in exchange for the underlying securities if a borrower fails to meet its debt agreements.

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