China's $134 Billion Maturity Wave Could Trigger More Defaults
China's $134 Billion Maturity Wave Could Trigger More Defaults
(Bloomberg) -- Investors in local-currency Chinese corporate bonds need to be on alert this year, with record maturities and a government crackdown on debt increasing the risk of more defaults.
There were six defaults on bonds in the first quarter, the most since the April-June period of last year, and investors and analysts are predicting more as interest rates rise and China clamps down on excessive borrowing. The tighter financing environment is hitting smaller private-sector firms hardest, as they haven’t benefited from capacity cuts.
These four charts show what’s underpinning the risk of more defaults in China:
1. Record notes due
Issuers rated AA and below, which are considered junk rated in China, face 840 billion yuan ($134 billion) of local bond maturities this year, 10 percent more than last year’s tally. As banks tighten lending criteria, investors are also getting more risk averse toward borrowers with lower ratings.
“We see divergence in investor demand for corporate bonds in China in the primary market,” said Yang Hao, fixed income analyst at Nanjing Securities Co. “There is appetite for higher-quality issuers and weaker ones may not be able to issue.”
Companies with AA or below ratings sold 248 billion yuan of notes in the first three months of the year, the lowest in four quarters, according to Bloomberg-compiled data.
2. Massive rating cuts
Of 407 companies with ratings of AA or below, almost half saw their credit score, as calculated by Bloomberg, downgraded in the past three months. In contrast, just 45 issuers were upgraded. Chemical producers suffered the most downgrades with 17 cuts, followed by real estate developers at 14, and metals and mining firms at 10, the data show.
“The credit condition is getting tighter, so rating companies are turning more cautious about company risks,” Xia Le, chief Asia economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. “The massive downgrades indicate more defaults down the road as they have now tightened rating criteria under heightened financial regulation.”
The spread between yields on AA rated three-year corporate bonds over Chinese government notes rose to 223 basis points in February, the highest since April 2015. The premium fell to 186 basis points after the People’s Bank of China injected more cash into the market during the top legislature’s annual meeting in March.
3. Cash crunch
Lower-rated firms tend to be smaller and their financial metrics have been deteriorating, especially their ability to generate cash. Publicly-traded companies in the ChiNext index of smaller firms had 43.3 billion yuan of net cash outflows in total during the most recently reported 12-month period, the most in at least six years, Bloomberg-compiled data show. By contrast, companies with the biggest market capitalization showed an improvement.
Investors have been avoiding smaller issuers for fear of default risks, according to Li Shi, senior analyst at China Chengxin International Credit Rating Co.
Cash flow is an important measure to gauge a borrower’s debt repayment capability. For Bluestone Asset Management Co., a local fund investing in bonds, companies with less liquidity to cover debt payments in the next three to six months should be avoided, said its senior credit analyst, Yin Shengjing.
4. Falling profitability
Profitability is also a worry as the metric has been sliding in the past two years for smaller firms in China, Bloomberg-compiled data show. As market share concentration continues among various industries in China, smaller firms will likely be less competitive, said Li Huaijun, chief analyst at First Capital Securities Co.
“We saw more diverging performance for companies in 2017 with more smaller and downstream companies being squeezed on pricing due to capacity cuts triggered by the supply side reform,” said Xia of BBVA. “Big companies were the ones reaping the benefit of such reform and enjoyed raw material priced boost.”
--With assistance from Kana Nishizawa Shuqin Ding and Vicky Wei
To contact Bloomberg News staff for this story: Lianting Tu in Hong Kong at ltu4@bloomberg.net, Ling Zeng in Shanghai at lzeng30@bloomberg.net, Yuling Yang in Beijing at yyang329@bloomberg.net.
To contact the editors responsible for this story: Neha D'silva at ndsilva1@bloomberg.net, Finbarr Flynn, Chan Tien Hin
©2018 Bloomberg L.P.
With assistance from Lianting Tu, Ling Zeng, Yuling Yang