China’s corporate bond spreads ease as supply shrinks
Chinese credit spreads have stabilised recently after a spectacular widening this year when tightened regulations triggered fears of a credit crunch. But this is not a signal that investors are returning to buy corporate bonds or that the health of Chinese companies is making significant improvement.
Chinese corporate bond yields may be merely taking a breather as supply shrinks due to issuance restrictions while some companies are turning away from the bond market back into traditional bank loans as another means to source their funding needs.
The 3-year credit spread between top AAA-rated and AA-rated onshore corporate bonds widened 158 basis points in the five months through end-February to a peak of 218 basis points, as investors priced in a bigger premium required to compensate for the riskier credit worthiness of lower-rated companies amid worries of financing pressure as the government implemented supply side reforms.
But the spread has since retraced by about 50 basis points to its current level of 168 basis points. Corporate bond issuance dropped sharply from 41.4 billion yuan (US$6.1 million) via 38 deals in April to 5.8 billion yuan via 9 issues in May before rebounding to 22.5 billion yuan via 21 bond issuances in June, according to Chinabond data.
“We expect issuance from most sectors, especially over-capacity sectors and government financing vehicles to decline,” Becky Liu, head of China macro strategy at Standard Chartered Bank said.
Liu forecast China credit bond issuance to drop 35-36 per cent on year in the second half, resulting in the lightest net issuance level since 2007. Goldman Sachs predicts private sector bond issuance to slow to about 10 per cent per annum over the next decade from 27 per cent in 2016, according to a research note.
However investor demand for corporate bonds, especially for lower-rated companies, remains weak because of dampened investor interest from continued deleveraging efforts.
Despite the shrinking corporate bond supply, credit yields may resume their rising trend thanks to worsening financial health of Chinese companies.
Standard Chartered predicted that credit spreads of AAA-rated and AA-rated onshore corporate bonds could widen by 25-30 basis points and 55-60 basis points in the second half. The 3-year AAA and AA bonds over policy bank bonds may increase to their widest spreads in two years by end-2017.
Meanwhile top-tier corporates may also switch from bond issuance to bank loans for fund-raising in the second half, Qu Xiaoqing, economist at DH Fund Management said.
Meanwhile, policies to curb corporate debt has been applied on a targeted basis to certain sectors only, indicating that corporate leverage is continuing to increase in China. For example, some large state-owned companies are increasing leverage while profit margins decline and worsen their debt burden.
Alicia Garcia Herrero, Asia-Pacific chief economist at Natixis said that financial health has improved for small Chinese companies. But she says large companies, from the real-estate, chemical and industrial sectors, continue to obtain implicit lending support from the government even though their profit margins are declining.
“Corporates living on borrowings and debt rollover, but could not generate enough profit for interest payment, have been a prolonged headache for the Chinese government,” Herrero said.