The recent spate of debt defaults by Chinese SOEs has shaken investor confidence in SOE bonds, which have always been considered safe, making Chinese companies a high-risk area for investment and cooling market demand for Chinese corporate bonds. The cost of financing new debt for Chinese companies has also risen to the highest level in two years as the market has become more wary.
The average coupon rate for exchange-listed bonds issued by Chinese companies rated below AAA was 5.89% in November 2020, the highest since January 2019, the Wall Street Journal reported on Dec. 9, citing data from WAND (Wind). In comparison, the coupon rate for AAA-rated bonds fell to 4.09%. A portion of China’s bonds are traded on exchanges, while others are traded in the so-called interbank market.
In addition, there have been delays and cancellations in Chinese corporate bond issuance, which has become an indicator of an inflection point in investors’ risk appetite. In total, $14.6 billion of bonds were delayed or canceled in November, the highest single month since the beginning of 2017, according to WAND data.
Li Chang, a Beijing-based director at S&P Global Ratings, said the rise in corporate borrowing costs was particularly evident in northeastern and western provinces, where local governments have limited fiscal strength. And borrowing costs are also rising in overcapacity sectors, which may include companies in mining, chemicals and heavy industry.
Most corporate debt in China is issued by state-owned enterprises, accounting for about nine-tenths of issuance in both 2019 and 2020, according to Rhodium Group data.
China’s credit ratings are flawed in measuring risk. Three recently troubled state-backed companies all have AAA ratings, including a coal miner, a wafer manufacturer and an auto company.
After the recent wave of defaults, investors are trying to figure out which companies are still truly creditworthy and which are part of important strategic industries that can continue to receive state support.
It’s a guessing game, more of a political game,” said Leland Miller, CEO of China Yellow Book; “It’s hard for the average investor to cut through the fog and pick the companies that might survive.
Hayden Briscoe, head of fixed income for Asia Pacific at UBS Asset Management, said the default rate for state-owned enterprises is expected to rise as the government pushes for consolidation in the sector.
Chinese companies have issued the equivalent of $2.3 trillion in yuan-denominated bonds as of Dec. 2, 2020, already 23% more than the 2019 total, according to Vanderbilt data.
However, with dwindling revenues, local Communist Party governments will not only be unable to continue to support the companies under their jurisdiction, but will also rely on them to raise debt to maintain their daily operations.
Rating agency Moody’s said in its latest report in December that China’s economy still faces downside risks and has a negative outlook for local governments in China in 2021.
According to Moody’s analysis, local government finances in the Communist Party of China remain constrained by a shrinking tax base, higher reliance on land concession revenues and greater reliance on direct borrowing and central transfer payments. The widening funding gap for local governments will increase pressure to rely on local SOEs to raise debt to support public infrastructure investment, creating higher contingent liability risk.
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