Echoes of US subprime seen in China debt ratings

Market warned that competition among China's rating agencies is leading to a fall in standards

PUBLISHED : Saturday, 08 March, 2014, 1:40am
UPDATED : Saturday, 08 March, 2014, 1:40am

Competition among China's credit-rating agencies is intensifying, leading to a slide in standards reminiscent of what happened in the US before the financial crisis, according to Dagong Global Credit Rating.

China's onshore bond market has seen its first default, with Shanghai Chaori Solar Energy Science & Technology failing to make an 89.8 million yuan (HK$113.7 million) interest payment which was due yesterday.

The solar cell maker sold one billion yuan of five-year debt in March 2012 and the notes were rated AA, the fourth-highest investment grade, by Pengyuan Credit Rating when they were issued. The debt was later downgraded twice, most recently to BBB-plus in April 2013.

"China's rating system has problems similar to those in the US in 2008," said Guan Jianzhong, the chairman of Dagong.

"There's cutthroat competition and it's not about who accurately evaluates the risks, but comes down to prices and ratings."

It’s not about [accuracy] … but comes down to prices and ratings

The US Financial Crisis Inquiry Commission said in 2011 that inflated credit grades were partly to blame for the worst downturn since the Depression that began in 1930, as rating companies lowered standards to win business amid a housing boom that fuelled issuance of mortgage-backed bonds.

China ended in 2012 a four-year ban on sales of asset-backed securities, and credit assessments are of growing importance as market forces play a greater role in pricing risk in its US$4.2 trillion bond market.

A default by Chaori may become China's "Bear Stearns moment," Bank of America Merrill Lynch said in a report, and may prompt investors to reassess credit risks as they did after the US securities firm was rescued in 2008.

The average yield on five-year AA-minus notes in China climbed 17 basis points in the last four days to 7.82 per cent, headed for the biggest weekly increase this year, ChinaBond data show. Ratings of AA-minus or below are equivalent to non-investment grades globally, according to Haitong Securities, the nation's second-biggest brokerage.

The average yield on junk corporate dollar debt surged to a record 22.66 per cent in December 2008, more than double the 9.68 per cent at the start of that year, according to the BofA Merrill Lynch High Yield Index.

JP Morgan Chase bought Bear Stearns in March 2008, when the latter was on the brink of failure, and six months later Lehman Brothers collapsed in the biggest bankruptcy in US history.

A missed payment by Chaori "won't pose systemic risks to China's bond market, but it's time to think about reforms in improving the rating system", Guan said. Credit-rating agencies should be made responsible for the grades they award companies and provide more details on how they come up with their assessments, he said.

Pengyuan was not available to provide immediate comment.

Dagong, which cut its US sovereign rating to A-minus from A on October 17, was set up in 1994 and is one of China's three biggest rating agencies. The other two are China Lianhe Credit Rating and China Chengxin International Credit Rating.