These Charts Show How One Part of China's Offshore Bond Market Is Changing Fast

(Bloomberg) -- City-level borrowers are storming China's international bond market.

The urban encroachment means that the country's offshore bond market is moving down the credit ratings spectrum with a greater proportion of new issuance coming from junk-rated financing arms, according to data from CreditSights Inc.

"The increase in city-level borrowers marks a deterioration in the quality of SOE issuers," said CreditSights analysts Sandra Chow and Luther Chai, referring to state-owned enterprises. "It also raises questions over why they are raising more funds offshore. Is it becoming harder for city-level SOEs to raise funding domestically?"

Debt sold by the financing arms of the country's towns and cities accounted for 18 percent of international bonds sold this year, up from 6 percent last year when they began making forays into offshore markets, according to the research firm. Dominance of central government-linked issuers has been on the decline, by contrast, falling to just over two-thirds from 97 percent in 2013.

Source: CreditSights

City-level entities are less likely to garner investment-grade ratings due to their reliance on mere "implicit" support from the Chinese government. That means the share of junk-rated issuance has risen to 11 percent year-to-date from none in 2015, according to CreditSights.

Source: CreditSights

This deterioration in the credit quality of bond issuers comes amid Beijing's step-up in its efforts against central government support for local governments. China announced a contingency plan last month, ordering local authorities to repay their own debt and reiterating that Beijing won't bail out regional governments.

CreditSights wrote on Nov. 20 that the announcement didn't seem to have material effects on outstanding notes of local government finance vehicles (LGFVs), with spreads actually tightening. But Chow and Chai also pointed out that the raison d'etre of their fundraising activity in the offshore markets is questionable.

Not only do they have to fall back on "implicit government support" to make up for their weak credit profile on a standalone basis, but LGFVs "only operate in China and have little reason to issue offshore from a functional standpoint."

Source: CreditSights

The analysts also added that falling commodities prices have changed the size and the make-up of the pie of issuers this year.

The nation's oil and gas giants, such as Cnooc Ltd. and China Petroleum & Chemical Corp., who churned out $11.2 billion last year, have largely remained on the sidelines in 2016, issuing just $6 billion year-to-date.

Source: CreditSights

Their absence has been filled by issuers looking to use proceeds for infrastructure development.

While the lull of behemoth oil and gas players means total issuance has fallen to $25.3 billion from $39 billion last year, Chow and Chai expect mergers and acquisitions will push more state-linked firms to the offshore bond market next year.

Source: CreditSights

One wrinkle in their forecast is the gap between announced plans and completed deals, which has also widened this year due to rising concerns over execution risks and capital flight.  

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