China Ratings Downgrade Wave Seen as Next Driver of Bond Slump

  • `Explosion of credit risks is spreading,' HFT Investment says
  • 33 issuer downgrades in 2016, versus 17 in year earlier period

China’s slumping onshore bond market is braced for rating cuts, as companies report weaker earnings and prepare for unprecedented debt maturities. 

China Securities Co. and HFT Investment Management Co. predict downgrades will surge as a slumping economy makes financial reports due by April 30 a gloomy read. Companies in China must repay 547 billion yuan ($86 billion) of onshore notes in May, the most in any month ever, data compiled by Bloomberg show. Investors are avoiding risky debt, with the yield premium on three-year AA- rated local bonds, considered junk in China, widening 43 basis points in April, the most since 2014.

QuickTake China's Debt Bomb

“An explosion of credit risks is spreading,” said He Qian, a Shanghai-based fund manager at HFT Investment Management Co., which manages 46.9 billion yuan of assets. “The risks are spreading from privately held companies to state-owned companies, from overcapacity industries to all other industries.”

At least seven companies missed bond payment this year, up from only two in the same period of 2015 as Premier Li Keqiang tries to rid industries with overcapacity of zombie producers. Onshore agencies have cut 33 issuer ratings, almost double the 17 for the first four months of 2015, according to China Chengxin International Credit Rating Co. There have been 34 upgrades versus 37 percent a year ago.

"We will see a wave of rating downgrades in the middle of this year,” said Wei Zhen, a money manager at Bosera Asset Management Co. She oversees the Bosera Anfeng 18-Month Interval Bond Fund, whose 17 percent return in the past year was the best among fixed-income funds tracked by research firm Howbuy. “The rising credit risks may lead to a further correction in the corporate bond market."

Chinese investors have complained onshore ratings don’t fully reflect issuers’ credit risks. More than 50 percent of Chinese locally-rated AAA bonds issued by listed firms may have default risk consistent with what Bloomberg’s quantitative, independent default-risk model deems below-investment-grade companies.

Shi Yuxin, a fund manager at HuaAn Fund Management Co., said in a report on April 18 that China’s “inflated” ratings will be under pressure to have “substantial” downgrades in 2016 as local governments cut their support for troubled companies.

Falling Value

About 14.9 percent of listed Chinese companies have forecast losses for 2015, compared with 12.7 percent in 2014, according to data compiled by China International Capital Corp. Ministry of Finance data released on Tuesday showed that profit at state-owned companies slid 13.8 percent in the first quarter from a year earlier.

Investors are fleeing the bond market. The market value of assets held by 718 onshore bond funds dropped last week, accounting for 95.6 percent of all the fixed-income funds tracked by Shanghai-based research firm Howbuy.

Ji Weijie, a bond analyst at China Securities, forecast the corporate yield premium over government notes may widen another 20 to 30 basis points and sentiment will only rebound if the government announces policies to support refinancing of industries struggling with overcapacity problems.

“A pessimistic sentiment is dominating the market,” said Ji. “Investors are pulling money out of bond funds on concern defaults will spread. Credit risks have triggered liquidity risks.”

— With assistance by Xize Kang, and Judy Chen

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