“The probability of China’s first onshore bond default is rising”; Fallen Angels Seen by Haitong on Record Downgrades: China Credit

Fallen Angels Seen by Haitong on Record Downgrades: China Credit

Record downgrades in China suggest more companies will lose investment-grade ratings as Premier Li Keqiang pares state intervention, according to Haitong Securities Co., the nation’s second-biggest brokerage. A total of 152 borrowers’ credit grades or outlooks were cut in the first nine months of this year, exceeding 73 for the whole of 2012, according to data compiled by Haitong. The yield on Anyang Iron & Steel Co.’s 2019 notes has jumped 396 basis points to 10.8 percent since China Chengxin Securities Rating Co. reduced its ranking to AA- from AA on June 28. Globally, fallen angels, or notes downgraded to junk, pay 4.9 percent, Bank of America Merrill Lynch indexes show.Investors are demanding higher yields to buy lower-rated debt after authorities ordered 1,400 companies in 19 industries including steel to cut capacity. Policy makers will outline more market reforms at a Communist Party summit next month. Chinese companies rated at AA-, considered speculative-grade in the country, must pay 313 basis points more than the government on five-year securities, near the most in more than five months.

“Capacity reduction may cause some companies to go bankrupt,” said Li Ning, a bond analyst at Haitong Securities in Shanghai. “Risks in steel, nonferrous and coal industries are rising.”

There is an increased chance that more credit ratings will be cut and those companies’ bond yields will rise above 10 percent, Li said.

Concerns Mount

There have been no defaults in the publicly traded domestic debt market since the central bank started regulating it in 1997, according to Moody’s Investors Service. Concerns have mounted since the biggest unit of Suntech Power Holdings Co. went into bankruptcy in March after defaulting on $541 million of offshore bonds. The next month, LDK Solar Co. failed to fully repay $23.8 million in dollar-denominated securities.

The rate on Jilin Provincial Coal Industry Group Co.’s 2016 yuan bond has risen 59 basis points to 6.16 percent since China Chengxin International Credit Rating Co. cut the borrower’s rating from AA+ to AA on Sept. 26, according to Chinabond data.

Christopher Lee, managing director of corporate ratings at Standard & Poor’s in Hong Kong, said last month Chinese companies will miss more debt payments in the coming year as the government switches the economy’s focus toward services. Companies in metals, mining, building materials, coal and transportation industries have elevated credit risks because their leverage is high and their capacity to service debt is low, according to Lee.

Default Watch

Long-term slowing of the world’s second-biggest economy is also increasing credit risks, and downgrades may reach another record next year, according to Haitong’s Li.

“The first onshore default is drawing near,” Li said. “It’s possible it could happen next year.”

While growth in gross domestic product accelerated to 7.8 percent in the third quarter, it still extended the longest streak of sub-8 percent growth in at least two decades. Industrial manufacturing and fixed-asset investment all slowed in September. Economic expansion will cool to 7.6 percent this year from 7.7 percent in 2012, before falling further to 7.4 percent next year, according to the median estimate of economists surveyed by Bloomberg.

‘Downward Trend’

“The economy is on a downward trend and some companies will see further deterioration in earnings,” said Dong Hui, a bond analyst at China Securities Co. in Beijing. Steel, coal, shipping and solar industries are facing the highest risks, he said.

Credit-default swaps insuring China’s debt against non-payment have increased 17 basis points this year to 83 basis points, according to data provider CMA.

China’s growth rate likely won’t decelerate sharply next year, suggesting downgrades may remain flat, according to Xu Hanfei, a bond analyst at Guotai Junan Securities Co. in Shanghai, the nation’s third-biggest brokerage.

Some market movements have pointed toward increasing economic confidence. As investors shift toward riskier assets, the rate on China’s benchmark 10-year government bond climbed to a more-than-five-year high of 4.22 percent on Oct. 25. The yuan traded at 6.0872 per dollar earlier today in Shanghai, near the 20-year high it marked last week at 6.0802, the strongest level since the government unified the official and market exchange rates at the end of 1993.

The government is more strictly monitoring Chinese rating companies’ accuracy and timeliness, which may prompt the credit assessors to take more cautious stances in reviewing borrowers, according to Haitong’s Li. The China Securities Regulatory Commission’s Shenzhen branch issued a warning on Aug. 2 to Pengyuan Credit Rating Co. saying it hadn’t released rating reports on Shanghai Chaori Solar Energy Science & Technology Co. (002506) in time.

“The probability of the first onshore bond default is rising,” said Yang Feng, a bond analyst in Beijing at Citic Securities Co., the nation’s biggest brokerage.

To contact Bloomberg News staff for this story: Judy Chen in Shanghai at xchen45@bloomberg.net

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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