China Debt Risks Go Global Amid Record Junk Sales Abroad

(Bloomberg) -- China’s riskiest corporate borrowers are raising an unprecedented amount of debt overseas, leaving global investors to shoulder more credit risks after onshore defaults quadrupled in 2016.

Junk-rated firms, most of which are property developers, have sold $6.1 billion of dollar bonds since Dec. 31, a record quarter, data compiled by Bloomberg show. In contrast, such borrowers have slashed fundraising at home as the central bank pushes up borrowing costs and regulators curb real estate financing. Onshore yuan note offerings by companies with local ratings of AA, considered junk in China, fell this quarter to the least since 2011 at 31.3 billion yuan ($4.54 billion).

Global investors desperate for yield have lapped up offerings from China. Rates on dollar junk notes from the nation have dropped 81 basis points this year to 6.11 percent, near a record low, according to a Bank of America Merrill Lynch index. Some investors have warned of froth. Goldman Sachs Group Inc. said last month that it sees little value in the country’s high-yield property bonds. Hedge fund Double Haven Capital (Hong Kong) has said it is betting against Chinese junk securities.

“Today’s market valuations are tight and investors are focusing on yields without taking into account credit risks,” said Raja Mukherji, Hong Kong-based head of Asian credit research at Pacific Investment Management Co. “That’s where I see a lot of risk, where investors are not differentiating on credit quality on a risk-adjusted basis.”

Lower-rated issuers turning to dollar debt after scrapping financing at home include Shandong Yuhuang Chemical Co. on China’s east coast. The chemical firm canceled a 500 million yuan local bond sale in January citing “insufficient demand.” It then issued $300 million of three-year bonds at 6.625 percent this week.

Some developers have grown desperate for cash as regulators tighten housing curbs and restrict their domestic fundraising. That’s raising concern among international investors in China’s real estate sector who have been burned before. Just two years ago, Kaisa Group Holdings Ltd. became the first Chinese property company to default in the offshore market. 

“Investors have to spend more time studying credit profiles due to the higher inherent risks,” said Chaksum Lau, assistant portfolio manager at China Securities International Asset Management Co. in Hong Kong. “Credit quality of the Chinese high-yield dollar market as a whole is deteriorating.”

To be sure, a bigger chunk of the risk-taking in the market for Chinese dollar bonds is now coming from investors from China itself. The increasing participation by Chinese buyers, who tend to hold their purchases for the long term, could help limit losses for foreign money managers if the market turns. The country’s banks have been buying 45 percent of new Chinese bond offerings, and are also active in the Chinese local government financing vehicle and investment-grade corporate sectors, according to a Bank of America report.

Still, the government’s property curbs could lead to more pressure on the real estate market than expected, according to Zhou Hao, a Singapore-based economist at Commerzbank AG. “When the huge amount of dollar property bonds come due in two or three years’ time, those weak developers may get into trouble,” he said.

The valuations of lower-rated Chinese developers don’t reflect their fundamentals, according to Kenny Wu, a senior credit analyst at BFAM Partners Hong Kong.

Unfamiliar Firms

While the surging international note sales will help bring more capital inflows to support the yuan following the currency’s biggest annual decline in more than 20 years, China’s authorities started curbing lower-rated bond sales to prevent risks. The Shenzhen branch of the National Development and Reform Commission said it will only allow firms with investment grade ratings to apply for offshore bond issuance, according to a statement dated March 1.

Even so, the market is expecting the jump in offshore high-yield bond sales to continue.

“The rising costs in the onshore market will motivate more onshore high-yield issuers to consider the offshore market for meeting their funding needs and expanding their funding channels,” said Ivan Chung, head of Greater China credit research at Moody’s Investors Service. “We currently expect to see more high-yield issuers from other sectors.”

--With assistance from Denise Wee

To contact Bloomberg News staff for this story: Judy Chen in Shanghai at xchen45@bloomberg.net, Carrie Hong in Hong Kong at chong61@bloomberg.net.

To contact the editors responsible for this story: Andrew Monahan at amonahan@bloomberg.net, Neha D'silva at ndsilva1@bloomberg.net, Ken McCallum

With assistance from Judy Chen, Carrie Hong