Flood of Junk Issuance Raises Risks in China's Bond Market

(Bloomberg) -- A challenge for investors all over the world, corporate governance is becoming a particularly thorny hurdle for investors in China’s bond market as the amount of low or unrated borrowers swells.

Take the case of China Huiyuan Juice Group Ltd. Dollar bonds of the junk-rated drinks maker slumped to record lows last week after the Beijing-based company disclosed that loans it gave to another firm with links to its chairman were in breach of stock exchange listing rules. It followed another incident in March, where notes of Tongchuangjiuding Investment Management Group Co., a financial firm, fell to an all-time low after it was investigated by China’s securities regulator for violating rules.

Investors have been lulled by years of implicit support for troubled local companies, but now with Beijing pulling back and allowing defaults, that buffer isn’t there anymore. With China’s dollar bond market coming off a record year for sales, the uptick in lower-quality issuance could spell trouble ahead. Bonds issued by high-yield and unrated companies have climbed to 55 percent of total sales this year, the most since 2011.

“In the past 12 months, we saw many lowly rated issuers from China in the single B category with weak financial profiles tap the offshore bond market,” said Christopher Lee, managing director of corporate ratings at S&P Global Ratings in Hong Kong. “These names tend to have a mixed track record in financial management. We expect potentially more governance issues coming to the fore for them.”

Investors were forgiving last year as liquidity was strong and the desire to chase yields was high, said Lee. Now, corporate governance issues “would be on everyone’s mind” in a weaker market, he said.

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Rising Treasury yields and higher short-term borrowing costs have led to softness in the market this year as investors expect heavy supply from Chinese issuers.

Investors should look closely at the management, “because they are the ones driving the fundamentals of a company,” said Raymond Chia, head of credit research for Asia ex-Japan at Schroder Investment Management Ltd.

Here is a list of recent corporate governance issues from Chinese bond sellers.

China Huiyuan Juice Group Ltd. (Related-party loan)

• The company said in a stock exchange filing it loaned money to a company related to its chairman with no written agreement. It has sought waivers from lenders because the governance lapses may have triggered events of default in financing documents.
• Huiyuan made the loan with the intention to get extra income from idle cash, but the action violated listing rules, according to a press release sent by its public relations firm in response to Bloomberg queries.
• Its dollar bonds fell to record low of 84.7 cents on the dollar last week.

Tongchuangjiuding Investment Management Group (Related-party transactions)

• In February, the financial group announced several related-party deals, including a transfer of shares in some subsidiaries to a listed company for free. It said in a statement late March it is under investigation from a regulator for a violation of rules.
• A call to the company’s general line didn’t go through while the company didn’t respond to an email seeking comment.
• Its 2020 bonds fell to record low late March after S&P placed its BB senior unsecured debt on credit watch.

Reward Science and Technology Industry Group Co. (Lack of disclosure)

• In 2015, Reward spun off part of its daily consumer products business but only disclosed it in June 2017, Moody’s said in a report in July. The disclosure shows Reward’s need to improve its transparency and timeliness, Moody’s said.
• An operator at Reward won’t connect to its investor relations department without a name. The company didn’t respond to an email for comment.
• Its 2020 dollar bonds plunged in July as Moody’s and Fitch cut its ratings.

Shandong Ruyi Technology Group Co. (Ownership discrepancy)

• The company said in a bond offering in June last year a local government financing vehicle owned 26 percent of the firm. But the LGFV in its own bond prospectus said it had no stake in Shandong Ruyi as of end-2016. Days later, Shangdong Ruyi said in a statement the LGFV remained the "legal owner" of the stake.
• The company didn’t respond to an email seeking comment and there is no phone number listed on its contact page.
• Its 2022 dollar bonds slumped to record low of 88.6 in July and they were indicated at 90 cents on April 10.

Shandong Yuhuang Chemical Co. (Cross guarantee)

• The company provided 1.35 billion yuan ($214 million) debt guarantees to unrelated firm Hongye Chemical and its units as of June 27, a China Lianhe Credit Rating Co. report showed. Hongye said in an exchange filing in June trading of its onshore bonds would be suspended due to uncertainties in its operating performance.
• A call to Yuhuang’s general line went unanswered and the company didn’t respond to an email seeking comment.
• Yuhuang’s 2020 dollar bonds fell to 93 cents in July last year from near par in early June, and they were indicated at 90.4 cents on April 10, a record low.

The corporate governance issue has been a “live” one, but it gets neglected due to low default rates, said Jin-ha Kim, head of global fixed income for Mirae Asset Global Investments in Seoul.

“I expect more frequent governance-related issues when the liquidity base shrinks,” Kim said.

To contact the reporters on this story: Lianting Tu in Hong Kong at ltu4@bloomberg.net, David Yong in Singapore at dyong@bloomberg.net.

To contact the editors responsible for this story: Neha D'silva at ndsilva1@bloomberg.net, Chan Tien Hin

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