China's Junk Bond Rally Seen Threatening to Spread 'Land Mines'Bloomberg News
Credit events tailed off, but will get worse: HFT Investment
Issuers must repay record 90 billion yuan of bonds in 2nd half
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China’s local junk bond rebound -- and an accompanying revival in issuance -- is fueling concern that investors are betting on the riskiest firms at just the wrong time.
Bond buyers are increasingly on the prowl for high-yield assets following a decline in money-market rates and after the number of defaults halved in the second quarter. Non-bank companies with local ratings of AA or lower, considered speculative grade in China, increased issuance of yuan-denominated bonds by almost three times last month from May. Such firms sold 24 billion yuan ($3.5 billion) of notes, the most since November, according to data compiled by Bloomberg.
The good times won’t last, say money managers HFT Investment Management Co. and Bosera Asset Management Co., which expect more companies to run into problems meeting debt repayments in the second half as the government continues a deleveraging drive. Investors must also consider the danger of hidden debt guarantees, after the issue flared again last month with two chemical makers in the nation’s east.
“The number of credit events in the second half may exceed that in the first half,” as companies that have taken on more debt buckle under the servicing costs for those obligations, said Lu Congfan, a fixed-income assistant fund manager at HFT Investment Management Co. “If you step on a land mine in your lower-rated bond investment, you will suffer big losses. Such investments aren’t appropriate for many investors.”
China’s junk-rated borrowers also face a looming maturity wall, with a record amount of bonds coming due in the second half. While investor demand remains resilient for now, with spreads narrowing in June even amid the heavy issuance, speculation is mounting that regulators’ patience is limited. The government will continue its crackdown on excessive borrowings, fueling debt repayment pressure for weak companies, said Lillian Li, a senior analyst at Moody’s Investors Service.
So far, holders of Chinese junk bonds have made out well after the recent market rebound. The yield premium on three-year AA- rated corporate securities over AAA notes has dropped 36 basis points since May 31 to 143 basis points, the lowest since 2013.
Still, longer-term market strains haven’t gone away. Even after yields dropped in June, financing costs for junk borrowers remain elevated. The average yield on AA- rated notes due in three years has averaged 6.2 percent this year, up from 5.47 percent in 2016.
“Investors are chasing high-yield bonds to boost returns as regulatory rules prohibit them from adding more leverage,” said Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co. “I don’t think the rally will last long because general monetary easing by the central bank is unlikely in the short term.”
Adding to strains, China’s lower-rated firms must repay a record 90 billion yuan of bonds in the second half, according to Bloomberg-compiled data. Some troubled debtors have already shown signs of stress.
There are “big uncertainties” whether AA- rated Wuyang Construction Group Co. will be able to repay bonds because of funding pressure in the short term, Tebon Securities Co., lead underwriter of its notes due in 2018, said on Friday. Investors have an option to sell the construction firm’s securities back to it on Aug. 14. Two calls to Wuyang’s contact person listed on its bond prospectus went unanswered.
China City Construction Holding Group Co., which has defaulted four times on publicly issued notes, sees uncertainty in a bond interest payment due July 14, according to a statement dated July 7 on Chinamoney’s website. Li Meng, in the financial development department of the company, wouldn’t comment when reached by phone.
A mysterious rush of liquidity recently back into China’s financial system buoyed debt markets last month, even as it invited speculation that the longer-term crackdown on leverage remains intact. While only 14 onshore bonds have defaulted so far this year compared with 17 in the same period of 2016, that stems in part from the loose funding environment in place last year that allowed borrowers to raise cash to roll over debts.
The increase in liquidity doesn’t herald the return to such easy money. Shadow bank financing rose by 28.9 billion yuan in May, slowing from an increase of 177 billion yuan in the previous month, according to central bank data. Junk issuers sold 64 billion yuan of bonds in the first six months, compared with 177 billion yuan in the same period of 2016, Bloomberg-compiled data show.
“The leverage crackdown isn’t over,” said Chen Zhixin, head of fixed income research at Bosera Asset Management Co. in Shenzhen. “The general funding environment for lower-rated companies will be tough. Their fundamentals will weaken and credit risks may rise. We are avoiding lower-rated bonds in the short term.”
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— With assistance by Judy Chen