Worst yet to come for China company bonds on debt cuts

Bloomberg

The worst may not be over for Chinese corporate bonds as the government pushes ahead with its campaign to reduce leverage in the debt market, according to investors including Invesco Ltd.
The crackdown on the use of borrowed money to invest in financial assets has led to Chinese companies canceling 184 billion yuan ($27 billion) of bond sales this quarter, set for the most in a year. The extra yield on AA rated company bonds due in
five years over similar-maturity government securities rose to the highest since 2015 this month. Invesco said corporate debt premiums still aren’t big enough to reflect rising default and liquidity risks.
China is struggling to decrease the nation’s enormous debt pile without destabilizing the bond and equity markets. As growth slows in the world’s
second-largest economy, the central bank boosted cash injections this week. Bond yields have surged and stock declined in recent weeks, though, after regulators overseeing ban-
king, insurance and securities trading issued a flurry of directives, targeting everything from excessive borrowing to speculation in equities.
“While such coherent tightening of policy is positive for China’s economy and capital markets in the medium to long term, it will lead to short-term pains,” said Ken Hu, chief investment officer of Asia-Pacific fixed income at Invesco Hong Kong Ltd. “It is still too early to buy onshore renminbi corporate bonds as the selloff will likely persist.”
Hu expects company bond yields to continue to rise as default rates in China will possibly increase for the next six to 12 months.
“There’s a lot more room to correct,” said Edmund Goh, fixed-income investment manager at Aberdeen Asset Management Plc. “We continue to expect tight short-end rates despite a recent correction in growth data as we think the government is still not satisfied with the current property price and credit growth.” Chinese companies and banks still face 3 trillion yuan in bond repayments this quarter. Four firms have defaulted since March 31.
The one-year Shanghai interbank offered rate, a gauge for borrowing costs in China, has jumped 91 basis points this year to 4.28 percent, the highest level since May 2015. The yield premium of five-year AA rated corporate bonds over government notes widened 24 basis points this quarter to 201 basis points on May 15, the highest since October 2015.
Shanghai Silver Leaf, a private fund company, said the leverage curb may continue into the second half of this year and more corrections in corporate bond prices are possible because non-banking institutions, authorized by Chinese banks to manage their assets, mainly hold such notes.
“Pressure on corporate bonds will materialize as the leverage crackdown extends in time,” said Chen Qi, a chief strategist at Shanghai Silver Leaf who was previously head of China fixed-income research at UBS Group AG. “But regulators probably don’t want to cause another cash crunch like in 2013. We won’t get deja vu.”
Schroder Investment Management Ltd. sees opportunities in AAA rated Chinese corporate bonds but is concerned that volatility will weigh on notes with lower debt scores, according to Angus Hui, a Hong Kong-based Asian fixed-income fund manager at the firm. “Right now we are still very cautious towards lower quality names,” Hui said.
China’s corporate debt was 116 trillion yuan as of the end of last year, accounting for 156 percent of the nation’s gross domestic product, according to Bloomberg estimates.
Raymond Gui, senior portfolio manager at Income Partners Asset Management (HK) Ltd., said even as there might be more defaults from sma-
ller and weaker companies, deleveraging will offer investment opportunities in strong companies that have committed to cutting debt.