China investors turn to sovereign debt amid company defaults

Beijing / Bloomberg

There’s about to be a flight to quality in China’s bond market.
Fourteen of 22 respondents in a Bloomberg survey of investors and analysts said they are most interested in buying securities issued by the government and policy banks in the next quarter, compared with just four of 19 in a similar poll three months ago. A run of defaults is the biggest risk facing China’s bond market in the next three months, and yield premiums are poised to widen, according to the most popular responses in the survey.
The change in sentiment comes amid rising pressure on local companies, with the number of bond failures almost triple that of the whole of 2015 and a record $331 billion of debt due to be refinanced this year. The appeal of sovereign debt has risen in recent days, with the 10-year yield erasing this year’s advance after Britain’s vote to leave the European Union spurred demand for haven assets and as the central bank stepped up cash injections.
“There is still plenty of money in the market, and investors need to seek safer assets,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shenzhen. “After defaults by even some highly rated companies this year, investors are finding that only sovereign bonds can ensure safety. Credit risks will probably continue to worsen, as the economy is yet to fully stabilize.”
Bond sale cancellations and delays are likely to continue into the third quarter, according to 15 respondents in the June 24-27 survey. Fourteen said the frequency of defaults will have the biggest effect on credit premiums, followed by eight citing the government’s efforts to reduce both leverage and excessive capacity.
In an indication of increased demand, a Bloomberg China sovereign index is little changed from March-end even with issuance already climbing to three-quarters of last year’s total. Net financing of corporate notes went into the negative in May for the first time ever, while companies prepared to repay 2.2 trillion yuan of debt in the second half of this year.
The credit premiums of five-year AA rated corporate debt over the sovereign have fallen to 169 basis points, after touching a six-month high of 200 basis points in April, data compiled by Bloomberg show. The government yield fell three basis points on Thursday. Chinese industrial companies’ profits rose 3.7 percent in May from a year earlier, slowing from 4.2 percent in the previous month, an official report showed Monday.

Bond Failures
Seventeen publicly-traded bonds have defaulted so far this year, compared with six in 2015, data compiled by Bloomberg show. China’s corporate debt as a percentage of gross domestic product climbed to a record 165 percent last year, according to data compiled by Bloomberg.
“Issuance by the corporate sector will slow down” in the second half of the year, analysts led by Ivan Chung, head of Greater China Credit Research and Analysis at Moody’s Investors Service, wrote in a note on Wednesday. “There is little room for corporates to increase their leverage in the next 12–24 months.”
The participants in the Bloomberg survey included Bank of Nanjing Co., China Merchants Bank Co., China Guangfa Bank Co., Industrial Securities Co., Bank of Hebei Co. and Evergrowing Bank Co. Sixteen investors and analysts asked not to be named as they are not allowed to comment on the matter publicly.