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China Local Yuan Junk Debt in Worst Selloff Since 2014

  • Onshore AA- yuan bond yield spread rises 17 basis points
  • `We should avoid junk bonds,' says HFT Investment Management

China’s onshore yuan high-yield bonds are in the midst of their worst two-month selloff since the end of 2014 and investors say they have yet to fully price in the risk of defaults as the economy slows.

QuickTake China's Debt Bomb

The yield premium for local seven-year corporate bonds with AA- ratings, considered junk in China, over similar-maturity government notes widened 17 basis points in March and April, the biggest two-month increase since December 2014. The gap reached a four-month high of 379 basis points, from as low as 352 on Jan. 19, as at least seven companies reneged on local bond obligations this year, up from one in the same period of 2015.

“Most high-yield bonds haven’t fully priced in default risks,” said Zhao Hengyi, Shanghai-based deputy director of the bond fund department at HFT Investment Management Co., referring to onshore yuan notes. The firm oversees 46.9 billion yuan ($7.2 billion) of assets. “We should avoid junk bonds.”

The slump in lower-rated onshore bonds contrasts with gains in Chinese corporate notes in the offshore junk bond market, which includes many property developer securities that have been buoyed by a rebound in the real estate industry. The yield premium on Chinese high-yield dollar notes has dropped 147 basis points since Feb. 29 to a more than three-month low of 660 basis points, according to Bank of America Merrill Lynch indexes.

Onshore-Bond Cancellations

China’s corporate debt burden is heavy, but if you have a lot of savings and lending, the leverage compared with countries without high saving rates is not very high, People’s Bank of China Governor Zhou Xiaochuan told a briefing in Washington on Thursday. The PBOC has lowered benchmark interest rates six times since 2014, underpinning a jump in debt to 247 percent of gross domestic product.

Premier Li Keqiang has pledged to pull support from zombie firms that have wasted financial resources and dragged on economic growth, which slowed to 6.7 percent in the first quarter. Chinese companies must repay a total of 31.3 billion yuan of onshore bonds rated AA- or lower this year, the most on record, according to Bloomberg data based on rankings from the nation’s four-biggest rating firms.

At least 37 Chinese firms postponed or scrapped 35.2 billion yuan of planned local note sales through April 13, compared with nine companies pulling 12.4 billion yuan a year ago, data compiled by Bloomberg show. About half of the cancellations took place this week after state-owned China Railway Materials Co. halted its bond trading Monday.

“The recent default events have hurt investors,” said Xu Gao, chief economist at Everbright Securities Co. in Beijing. “So it’s natural for bond yield spreads to go up.”

— With assistance by Lianting Tu, and Judy Chen

(Corrects story published April 15 to specify local yuan bonds in headline and lead.)
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