China junk bond premium jumps

Shanghai: China’s junk bond yield premium is climbing at the fastest pace this year on concern an extended slump in the world’s second-biggest economy will cause a default.

The extra yield investors demand to hold five-year notes rated AA over similar-maturity sovereign debt widened 15 basis points this month to 245 as of August 17, poised for the biggest monthly increase of 2012, according to Chinabond data. US speculative-grade bonds yield 632 basis points more than Treasuries, Bank of America Merrill Lynch data show.

Chinese banks’ bad debts rose in each of the last three quarters, the longest run of increases in eight years, and the nation’s first bond default was averted in April when Shandong Helon paid off 400 million yuan (231 million) of notes at a time when it had 957 million yuan of overdue loans. Premier Wen Jiabao said last week downward pressure on the economy remained “relatively large” and money-market rates are climbing as the central bank refrains from cutting lenders’ reserve requirements.

“At the moment, the government’s policy isn’t strong enough to help the economy bottom out so Chinese companies’ profit decline cycle will last longer than expected,” said Zou Yu, a Shanghai-based fund manager at Wanjia Asset Management, which oversees 29.7 billion yuan of assets. “We may see the first bond default in China within two to three years.”

Solar slump

Companies involved in the manufacture of solar panels are among those most at risk as an industry glut drives down the price of their products. The selling price for Chinese crystalline silicon modules, a global benchmark, averaged 89 cents per watt this year, down from $1.24 (Dh4.5) in 2011, $1.80 in 2010 and as high as $4 in 2008.

The yield on AA rated Shanghai Chaori Solar Energy Science & Technology’s bond due March 2017 has surged 108 basis points to 8.47 per cent as of 11.14am in Shanghai on Monday since the company on July 13 forecast a first-half loss of at least 120 million yuan. Pengyuan Credit Rating cut the outlook on its rating for the debt to “negative” from “stable” on June 28, citing the solar-cell maker’s rising liabilities.

China International Capital, the nation’s biggest investment bank, and GF Securities say grades of AA or below at domestic ratings companies denote similar creditworthiness as non-investment grades in the US, which are also referred to as junk. AA is the third-highest of ten investment grades at Standard & Poor’s.

‘Dangerous’ debt

China’s corporate debt-to-GDP ratio has reached a “dangerous” level, the China Daily reported on August 7, citing Li Yang, vice-president of the Chinese Academy of Social Sciences, a government-backed agency. The ratio was 107 per cent, the highest in the world, Li said, according to the newspaper.

Wanjia’s Zou said some debt ratings may be downgraded this year because of issuers’ cash flow problems. Zou’s Wanjia Tianli Bond Fund B has handed investors a return of 28 per cent, the second-best performance among 300 China bond funds tracked by Bloomberg.

“Downgrades may first occur in those industries with overcapacity, such as steel, non-ferrous metals and photovoltaics,” said Zou.

LDK downgrade

LDK Solar, the world’s second-biggest maker of wafers that convert sunlight to power, has reported losses for each of the four quarters through March and said in May it might be unable to remain a “going concern” if it can’t raise funds. Shanghai Brilliance Credit Rating & Investor Service in June lowered the rating on the company’s bonds to A+ from AA, according to a statement on its website.

The yield on LDK’s 6.8 per cent note due December 2014 has risen 84 basis points in the past month to 8.25 per cent, according to data compiled by Chinabond, the nation’s biggest debt clearing house. The local government of the eastern Chinese city of Xinyu said in July it would pay a portion of the debts of LDK.

“It is possible that the first bond default will occur this year,” said Xu Hanfei, head of fixed-income research in Shanghai at GF Securities, China’s third-biggest listed brokerage. “On one hand, there is no obvious rebound in overseas and domestic demand. On the other hand, their financial costs haven’t declined. The first bond default may occur in upstream industries, such as energy or mineral companies with high leverage.”

Yields rising

The yield premium investors demand to hold five-year top-rated corporate debt rather than government bonds in China has widened six basis points this month to 145, according to Chinabond. The yield on five-year sovereign debt increased 21 basis points to 3.07 per cent as of August 17. The seven-day repurchase rate, a gauge of liquidity in the financial system increased 24 basis points since July to 3.61 per cent.

Confidence in the Chinese government’s ability to pay its debt is rising. The cost of insuring sovereign bonds against default fell 13 basis points this month to 99, according to data provider CMA, which is owned by McGraw-Hill. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

The yuan strengthened 0.03 per cent this month to 6.3609 per dollar in Shanghai, according to the China Foreign Exchange Trade System. The economy expanded 7.6 per cent from a year earlier in the second quarter, the least in three years, and July data showed slowdowns in industrial output, retail sales and exports.

Risks building

No company has failed to make payments on publicly traded debt in China since the central bank started regulating the market in 1997, according to Moody’s Investors Service. Globally a total of 32 companies defaulted this year, up from 16 in the same period of 2011, Standard & Poor’s said May 31.

“The first bond default won’t occur this year, but long-term systematic risks are building up as economic growth slows,” said Wang Yang, co-head of fixed-income research in Beijing for UBS Securities. “Companies in trouble may get financial support from the government, like what happened to LDK. After all, a bond default is more serious than a loan default because that will affect more parties.”

Guotai Junan Securities, then the nation’s biggest brokerage by revenue, has recommended since June that investors avoid bonds rated AA or below because of the worsening economy.

“Concern about default risks will grow if the economy continues to be so bad,” said Huang Jiliang, a bond analyst at Guotai Junan in Shanghai. “Cyclical industries such as steel, real estate and shipping are the most dangerous ones.”