China’s Ugly Duckling Industry Bonds Turn Into Swans on Support

Updated on
  • Coupons for notes in overcapacity sectors dropped in July
  • Price changes on those bonds can be volatile, analyst says

China’s ugly duckling industrial bonds have been looking a bit more like swans amid stronger support from the nation’s government. Analysts are questioning whether the transformation will last.

Local yuan debentures from issuers in industries including coal, metals and mining outperformed their peers last month. The average coupon on AAA rated bonds in those sectors sold in July with tenors of one year or less dropped 45 basis points from June to 3.8 percent, according to data compiled by Bloomberg. That exceeded the 12-basis-point fall for all AAA rated securities.

Until a few month ago, investors had been shunning bonds from those industries as defaults spread. Their fortunes started to turn in June when local governments ranging from Shanxi to Shandong asked banks to help struggling steel makers and miners. China’s coal prices rose 8.1 percent in July, the sharpest monthly gain in almost three years. Yet analysts at Western Securities Co., Industrial Securities Co. and First Capital Securities Co. see uncertainty and higher competition in the steel and coal sectors.

Debt Due

“The performance of the bonds from overcapacity industries benefited from a rise in commodities prices and it is uncertain whether the trend will continue,” said Huang Weiping, senior analyst at Industrial Securities. “Some smaller players may rejoin the market, which could impact the profitability for the commodities industry overall.”

Chinese metals and mining companies face 143.7 billion yuan ($21.6 billion) of domestic notes coming due this quarter while coal operation firms owe 97.8 billion yuan, according to Bloomberg-compiled data. Both are among the five sectors in China with the most bond maturities between July and September.

The government in the northern province of Shanxi urged banks in June not to withdraw lending to the seven coal firms that it owns. The Shandong government took steps also that month to protect firms that have outstanding loans of 500 million yuan or more by asking banks to form committees to block any lender that tries to cut funding lines to the companies. China’s central planner National Development and Reform Commission said last week that it would push for mergers and acquisitions in the steel industry.

Local governments have strong intention to support big regional enterprises, but they have limited ability to do so, according to a Thursday report from Citic Securities Co. Excess capacity for many of those companies still exists, which will take a long time to eliminate, it said.

Volatile Prices

“Local governments have strengthened their support for overcapacity industries as we saw in Shanxi, which is positive for related bonds,” said Li Ning, general manager of the fixed-income department at Western Securities in Beijing. “But price changes on those bonds can be more volatile so investors should be very cautious.”

To be sure, July’s rebound came after a bad June. Average coupons for AAA rated notes with maturities of one year or less issued in June by borrowers in industries with excess capacity rose 100 basis points from the previous month, topping the 29 basis point average rise for AAA bonds overall, according to Bloomberg-compiled data.

“Although yields for bonds from overcapacity industries have come down recently, investors should watch out for the potential default risks, which could have a major impact on the markets,” said Li Huaijun, chief fixed-income analyst at First Capital Securities in Beijing.