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The Junk-Rated, JPMorgan-Owned China Bond Insurer Growing at 40%

  • United SME says its business is expanding despite junk rating
  • China defaults fuel concern over strength of guarantees

For most of the world’s bond insurers, a junk credit rating would be a devastating blow. Selling promises to pay someone else’s debt is a whole lot harder when your own financial strength is in doubt.

Unless, that is, you’re in China.

As the country’s bond insurance industry grows at a record pace, not even a cut to junk by Moody’s Investors Service has been able to stop the expansion of China United SME Guarantee Corp., a top-five debt insurer whose shareholders include JPMorgan Chase & Co. and Siemens AG. United SME says the April 7 downgrade had virtually no impact on its onshore business, which surged by as much as 40 percent in the first quarter.

Such breakneck growth at a time of spreading corporate defaults is fueling concern that China’s debt insurers will struggle to make good on their guarantees in the nation’s $3 trillion domestic corporate bond market. As the only player in China covered by Moody’s, United SME offers a rare glimpse into a lightly-regulated industry that the ratings firm predicts could face payment difficulties -- and even some bankruptcies -- as China’s credit cycle turns.

“I’m definitely worried,” said James Yip, a Hong Kong-based money manager at Shenwan Hongyuan Asset Management (Asia) Ltd., which has pared holdings of insured bonds in China and expects yield spreads on the debt to widen. “The kind of reassurance the guarantee companies could offer has waned.”

Rapid Growth

The financial strength of China’s nearly 8,000 guarantee companies is being questioned less than a decade after turmoil at U.S. counterparts MBIA Inc. and Ambac Financial Group Inc. helped fuel the worst financial crisis since the Great Depression.

While China’s insurers still cover a small fraction of the country’s total debt, they’ve been expanding rapidly. Such firms backed 61.4 billion yuan ($9.5 billion) of new bonds in the first quarter, up more than seven-fold from a year earlier, according to Dagong Global Credit Rating Co., one of the nation’s top three graders.

Brisk growth was one of the factors cited by Moody’s in its downgrade of United SME to Ba1, the level just below investment grade. The ratings firm expressed concern that the insurer’s fast-expanding portfolio hasn’t been tested in a credit-market downturn. Moody’s also pointed to a drop in implicit state support after a stake reduction by Export-Import Bank of China, which declined to participate in a new share sale announced by United SME in January.

“I expect more guarantee companies to get into trouble this year,” Sally Yim, a Hong Kong-based senior vice president at Moody’s, said in an interview. While an industry-wide collapse is unlikely as state-backed insurers prove more resilient, smaller players are vulnerable, Yim said.


United SME, which still has a top AAA credit grade from Dagong and Fitch Ratings’ China joint venture, called the Moody’s downgrade “unprofessional.” The firm said it had to step in to repay just 1.32 percent of insured bonds and loans maturing in 2015 and that its net income for the year increased by about 67 percent.

“We don’t think it will turn into a situation where many guarantee companies collectively fail to service their obligations,” United SME said in an e-mailed statement on April 28. The company said its current backers include JPMorgan, with a stake of about 25 percent, and the Chinese unit of Siemens, with 6.8 percent.

JPMorgan didn’t reply to an e-mail seeking comment and Siemens declined to comment. The China Banking Regulatory Commission didn’t reply to a faxed query.

While United SME’s downgrade seems to have had little impact within China, the reaction was almost immediate in the offshore credit markets. Yields on three-year dollar bonds of BL Capital Holdings, which carry a guarantee from United SME, have jumped 65 basis points since the downgrade through Wednesday. The yield climbed two basis points on Thursday to 5.21 percent.

Investors have grown increasingly wary of Chinese bonds after the economy slowed to the weakest pace in a quarter century in 2015 and at least seven companies defaulted this year, including three with state backing. The yield on five-year onshore junk bonds has climbed to 6.5 percent from a low of 5.96 percent on March 17, according to ChinaBond, while Dagong estimates debt insurers have had to honor 154 million yuan of their clients’ obligations since last year.

The industry’s opacity is a concern, according to Moody’s. With none of the top debt insurers listed on stock exchanges, finding financial statements and shareholder information is difficult. Many incumbents, including Sanxia Guarantee Group and Shenzhen HTI Group Co., ranked by China International Capital Corp. as the nation’s third and fourth-largest guarantee companies by outstanding bonds and loans backed, don’t publish their earnings online.

Industry-wide data is also elusive. The latest estimate from the State Council on the size of credit guarantees in China -- 2.7 trillion yuan -- is from the end of 2014.

The absence of a designated government body to regulate the industry is part of the problem, according to Eunice Tan, Hong Kong-based director of financial services ratings at S&P Global Ratings. The industry currently receives guidance from seven overlapping regulators through an inter-ministerial body, while local governments are responsible for the guarantee firms’ supervision, Tan said.

Land Mines

China’s leaders are attempting to catch-up with the industry’s growth. The State Council in August invited public feedback on new draft guidelines, which include quadrupling the minimum capital requirement of local insurers and a 1 billion yuan minimum for companies with operations in multiple provinces. The National Development and Reform Commission said in March that China plans to set up a national guarantee fund.

In the meantime, Citic Securities Co., the nation’s largest brokerage, is advising clients to avoid putting too much faith in debt insurers’ guarantees.

“For the bond market, the problem that some guarantee companies may fail to repay debts will become a major risk that may lead to more defaults,’’ said Ming Ming, the Beijing-based director of Citic’s research department. “Financial institutions need to study borrowers’ fundamentals to clear the land mines, and shouldn’t blindly trust the guarantee companies.’’

— With assistance by Tian Chen

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