Photographer: Lucas Schifres/Getty Images

China Stemming Defaults Leaves Junk Bonds Hottest in 5 Years

  • ‘Government is trying to restore the market’s faith:’ Colight
  • Bond delinquencies one fifth of level in the previous quarter

China has stanched a string of defaults and speculation authorities will continue to stave off failures is leaving investors the most bullish on local junk bonds in five years, despite record maturities.

Only two notes have suffered nonpayment this quarter. That’s down from 10 in the second quarter and 7 in the first three months of the year. The average yield premium for five-year corporate securities with AA- ratings, considered speculative in the nation, over the sovereign narrowed 85 basis points to a five-year low of 262. The country’s state-owned assets regulator pledged last month to prevent bond delinquencies by central government-owned firms.

QuickTake China's Debt Bomb

The increased government involvement marks a turn from the beginning of the year, when mounting defaults sparked the biggest selloff in local junk debt since 2014 and forced firms to cancel financing plans. Government-owned China Railway Materials Co. had contributed to broader market stresses, when trading of its notes was suspended in April. As fears spread, the State-Owned Assets Supervision and Administration Commission stepped in to tell some of the firm’s debtors to repay obligations, people familiar with the matter said at the time.

"If the government stood aside and let a large number of companies default, it could have caused greater market panic and increased the risk of regional financial crisis,” said Wang Ying, senior director at Fitch Ratings in Shanghai. “When the government tries to weed out zombie companies, it needs to maintain stability in the financial market.” 

The government’s move comes ahead of 1.53 trillion yuan ($229 billion) of onshore bonds that come due in the fourth quarter, the most on record, compared with 1.48 trillion yuan in the previous three months, according to data compiled by Bloomberg.

"In the short term, government intervention helps stabilize the market,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shenzhen. “But in the long run, it isn’t good because it plays down the role of the market.”

The ranks of zombie companies in the nation’s $3 trillion corporate bond market are swelling. The number of Shenzhen and Shanghai-listed firms with net losses, falling revenue and short-term debt more than cash jumped to 188 from 176 a year earlier, data compiled by Bloomberg show.

“We can feel that the government is trying to restore the market’s faith in state-owned companies,” said Xu Hua, a Shanghai-based bond fund manager at Colight Asset Management. “The policy support may continue in the second half."

Risks Ahead

Not all are so optimistic. Guotai Junan Securities Co. forecast in a Friday report that there may be an "explosion” of credit risks in the fourth quarter because of the large amount of redemptions. The government may find "it doesn’t have enough strength when trying to bail out troubled companies,” it said.

Almost 90 percent of respondents say the number of companies that will default in the fourth quarter will be either slightly higher or the same as the third quarter, according to a Bloomberg survey of 17 onshore banks, brokerages, and asset management firms this month.

The state assets regulator said in an Aug. 24 statement it will improve its risk monitoring mechanism, "focus more on bonds maturing in the next three months and prevent defaults in order to maintain financial market stability." China Banking Regulatory Commission this month warned lenders against withdrawing support from firms struggling to pay back debt.

State planning is making a comeback. Zhang Anshun, head of the Shanxi branch of the CBRC, said on Sept. 20 that while 21 mines will be closed, banks should help good coal firms to expand funding channels and cut leverage.

“The government is concerned about the risks brought by too many defaults and we speculate it is willing to bail out troubled companies,” said Mo Qian, Shanghai-based head of fixed income research at HFT Investment Management Co., adding that credit spreads may narrow further in the fourth quarter. “But it also depends on whether the companies are zombie firms and their influence on regional economies.”

— With assistance by Judy Chen

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