The dragon, this year’s sign in the Chinese zodiac, is revered as a symbol of strength and prosperity. However, recent developments in the country’s debt markets have done little to inspire confidence.
Source: Reuters/Carlos Barria
A man holds a dragon balloon outside Longhua Buddhist Temple on the first day of the Chinese Lunar New Year in Shanghai
China may have just ushered in the Year of the Dragon, but its debt markets are looking far from mighty. A growing awareness of credit risk is driving overwhelming demand for government-supported and top-rated deals, while lower-rated entites are struggling to find the funding they need.
State oil company China National Petroleum Corp in January received orders totalling a staggering Rmb680bn (US$107.5bn) for a Rmb20bn deal, reflecting Chinese investors’ growing aversion to riskier names.
Many market participants told IFR they intended to stick to AAA to AA+ investments as a policy in the New Year, at least for the first quarter, and “to see if the market condition changes afterwards”.
Investors are growing increasingly nervous about defaults as China’s economic growth slows, and those fears are turning highly rated bonds from well-known companies with good assets and solid businesses into safe havens.
Default risk is a relatively new concept in China’s bond market, where companies have only been allowed to sell bonds without a bank guarantee since 2005. Yet, long-standing fears of a wave of defaults are beginning to look justified. For the first time in the history of China’s bond market, a corporate issuer – Beijing DG Telecommunications Equipment, a manufacturer of wireless systems –asked its guarantor to cover its debts as its business had deteriorated significantly.
“It’s hard to have confidence in lower-rated deals. You can call us conservative, but Triple A or Double A-plus rated companies are good credits for a reason. With all the bad news out there, we really don’t want to take the risk,” said a trader at an asset management company.
The surge in demand for top-rated bonds comes as a number of smaller issuers and local government-linked entities are struggling to repay their obligations. Serious doubts are being raised about the ability of local government-backed companies to repay the jumbo-sized enterprise bonds issued in the last few years.
“The credit worries have destroyed the market for so-called ‘CIC bonds’, issued by city investment and city construction investment companies and guaranteed by local state-owned entities,” said one bond sales officer. “We doubt it will truly recover this year; people out there are still very cautious.”
However, many such issuers are still looking to come to market. Sources told IFR that almost every securities house had some lower-rated deals in the works, and many were under pressure to come to market soon before regulatory approvals from earlier in 2011 expired.
“We do have many lower credits and CIC deals from last year, and we have to sell them off this year,” said another sales officer with a top underwriter of enterprise bonds. “I don’t expect it’ll be easier to sell, but I hope good investors will be able to pick out the better ones from the rest. Not every CIC bond is risky.”
Rating agencies under scrutiny
China’s authorities are aware of the problem and have taken measures to develop the ChiNext board private-placement bond market and the high-yield bond market as funding alternatives.
It is the latest sign that China is looking to ease funding pressures for small and medium-sized enterprises, seen as important engines of future economic growth. The plan, however, will be a test of appetite for lower-rated credits in the country’s conservative bond markets.
The growing focus on credit risk has led to the role of the rating agencies being seriously questioned, after more downgrades in 2011 than ever before. Many small institutions have started to build internal rating systems in an effort to control their investment risks.
On December 19, Shenzhen-listed Shandong Helon became the first Chinese issuer to lose its investment-grade rating. It was reported to have missed Rmb397m in loan payments.
China Lianhe Credit Rating downgraded the company twice last year with the latest assessment being in December. The company was downgraded from A+ to BB+, while its A+ rated Rmb400m one-year CP, issued in April 2011, was downgraded from A2 to B.
A credit analyst familiar with the matter told IFR that, sometimes, an issuer’s future credit standing was just impossible to predict.
“Sometimes, it is very hard for us to tell the truthfulness of the disclosures by an issuer provides,” said the analyst. “Low-rated issuers usually have much less stability in their businesses, which will always be reflected in our follow-up ratings reports.”
She admitted that rating agencies tended to consider the “invisible support” of local governments as a factor, while rating CIC deals. Even without a good profit or steady cash flow, the issuer may still receive a decent rating.
“We are considering some changes to the current rating method for enterprise bonds that local government-linked entities issue,” said the same analyst. “As far as I know, we are not the only firm considering this. Credit developments are putting all of us under pressure.”
