Photographer: Qilai Shen/Bloomberg

China Corporate Bond Sales to Rise Next Quarter, Survey Says

  • Premiums on lower-rated securities set to widen further
  • Echoing Moody’s, respondents see first LGFV default coming

Even with a clampdown on leverage set to continue, Chinese companies are likely to step up bond sales in coming months, helping reduce any hit to economic growth.

All but one of 26 fixed-income traders and analysts forecast an increase in domestic corporate bond issuance in the third quarter from the previous three months, according to a Bloomberg News survey taken June 23-26. Sales this quarter have totaled 1.5 trillion yuan ($221 billion), up 18 percent from January to March, yet still well below the quarterly average of 2.2 trillion yuan over the last two years, according to data compiled by Bloomberg.

“We are relatively optimistic about China’s bond market in the third quarter,” said Zhang Rui, a fixed income director at Changjiang Securities Co. in Beijing. “Regulation will be the biggest risk to the market. If there are no drastic policies in the third quarter, bond yields will have room to come down.”

Conditions are far short of a revival of risk appetite though: most respondents saw higher-rated corporate bonds and government-linked securities outperforming lower-quality paper. Firms canceled some 260 bond sales this quarter, totaling a record 245 billion yuan. Premiums over government securities have climbed in 2017, as have government yields themselves, pushing up the cost to borrow as policy makers sought to rein in leveraged bets on fixed income.

Government bonds are seen rallying in coming months, read about that here.

With tighter regulatory scrutiny of financial instruments including wealth management products and negotiable certificates of deposit, which are used to back debt purchases, it’s been a rough few months in the world’s third-largest bond market. Yields on five-year Chinese government bonds rose about 39 basis points in the second quarter. Lower-rated debt underperformed, with the gap between AAA and AA rated five-year corporate bonds widening about 28 basis points, to about 77 basis points.

Some further results of the survey:

  • About three quarters of respondents see the premium of AA over AAA corporate bonds widening next quarter. Most see a rise of as much as 50 basis points.
  • Half expect the number of bond defaults in July-to-September to be similar to this quarter, when five publicly listed securities defaulted, according to data compiled by Bloomberg.
  • More than half predict a local government financing vehicle default by the end of 2018.
  • Foreign investors will hold 1 trillion yuan of onshore bonds at the end of this year, according to the median estimate, up from 830 billion yuan at the end of March and 853 billion yuan at the close of 2016.

An LGFV default would be a milestone in China’s bond market, read more about that here.

Greater differentiation in borrowing costs for Chinese issuers would be a good sign that the industry is starting to mature, after years during which investors assumed varying degrees of government guarantees.

“Improving the cost and allocation of capital onshore is one of the top financial market reforms for China,” said Freddy Wong, a portfolio manager at Fidelity International in Shanghai. “Increased credit differentiation will mean that the cheapest available capital will make its way to more efficient and productive sectors and companies.”

— With assistance by Yuling Yang, Jing Zhao, Lianting Tu, Shuqin Ding, Helen Sun, Xize Kang, and Ling Zeng

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