China’s corporate bond market reels from interbank borrowing costs

Bloomberg

China’s $3.2 trillion corporate bond market is already starting to reel from rising interbank borrowing costs, and the traditional year-end funding crunch hasn’t even started yet.
The yield premium for five-year AA rated notes over the sovereign climbed 10 basis points in October as money market rates surged to an 18-month high. Worse may be yet to come as lenders tend to hoard cash for year-end regulatory checks, prompting the overnight repurchase rate fixing to rise in December in four of the past five years, including a 33 basis point jump in the last month of 2015.
China’s bond market has had 11 consecutive quarters of gains as investors bet the central bank would keep interest rates low to support an economy growing at the slowest pace in a quarter century. The advance has faltered as the People’s Bank of China focuses on cutting debt, pushing up short-term borrowing costs to discourage speculative trading.
“The real challenge will come later this month, when asset allocation demand wanes as we enter the year-end,” said Shi Lei, head of fixed income research at Ping An Securities Co. in Beijing. “Huge demand for assets that can generate safe returns were behind the bond rally, as investors bet continuous inflows into the market will drive up prices. When the liquidity disappears, it’ll be a problem.”
Banks, mutual funds and insurance companies have trimmed corporate bonds due to falling liquidity and unattractive yield premiums, said Meng Xiangjuan, head of fixed income research at SWS Research Co.. The AA spread reached a record low of 95 on Oct. 13. Outstanding repurchase agreements — where investors pledge existing bond holdings for cash to buy more debt — fell to 8.9 trillion yuan on Oct. 31 from a record 9.7 trillion yuan at the end of 2015. Transactions of overnight repos dropped 18 percent last month, National Interbank Funding Center data show.
“The PBOC will introduce some volatility in the money market to guide market participants to cut excessive borrowing,” said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore. “Corporate notes will probably be more severely affected in the deleveraging progress, as current credit premiums are not reflecting the risks. This could lead to a rising number of credit events.”
Any disruption in the market could make it harder for companies to refinance as 4.1 trillion yuan ($605 billion) of bonds coming due next year. The number of defaults in publicly-traded notes declined to three since July, compared with 10 in the second quarter and seven in the first three months of this year.
The central bank started to use longer-term reverse repos in August, helping drive both overnight repo rates and the one-year interest-rate swap to the highest level since April 2015 last month. The PBOC said in its third-quarter monetary policy report released on Tuesday it will “proactively cut leverage and prevent
bubbles.”

‘Drop Inevitable’
“Most of those who are highly leveraged put their money in corporate bonds,” said Wu Sijie, a Shanghai-based bond investment manager at China Merchants Bank Co. “If money rates stay elevated, it is inevitable bond prices will fall. Short-term interest rates will be the dominant factor impacting the market now.”
Policies to rein in property bubbles are starting to take effect, with Beijing home sales plunging 41 percent by volume in October from a year ago and Shanghai’s slumping 18 percent, China Real Estate Information Corp. data show. The economy is forecast to expand 6.7 percent this year, the least since 1990, and slow further to 6.4 percent next year, according to Bloomberg surveys.
That hasn’t been reflected in the bonds of the nation’s biggest developers. Dalian Wanda Commercial Properties Co. sold 6 billion yuan of three-year notes on Sept. 23 at a coupon of 3.64 percent, and issued the same amount of such securities one month later at 3.40 percent.
“The slowdown in the real estate sector is likely to worsen the credit profiles of some low-rated companies,” said Wang Yifeng, an analyst at China Minsheng Banking Corp.’s research institute. “As banks, the biggest investors in bonds in China, enhance risk controls, some of these notes will be excluded from the
investment pool.”