China's Rating Cut Exposes Firms Hooked on Dollar Borrowing
(Bloomberg) -- China’s first credit rating downgrade by Moody’s Investors Service since 1989 couldn’t have come at a worse time for the nation’s companies, which have never been more reliant on the overseas bond market for funding.
While Chinese companies’ foreign-currency debt is only a fraction of the $9 trillion local bond market, China Inc. is on pace for record dollar bond sales this year after the authorities’ crackdown on financial leverage drove up borrowing costs at home. Overseas borrowing has also been part of the government’s strategy to encourage capital inflows in a bid to ease the depreciation pressure on the yuan.
Airlines and shipping companies, which finance the costs of new aircraft and vessels with debt, are particularly vulnerable to higher borrowing costs, according to Corrine Png, chief executive officer of Crucial Perspective in Singapore. Khoon Goh, head of Asia research for Australia & New Zealand Banking Group, sees state-owned enterprises among firms feeling the biggest impact.
Companies including State Grid Corp. and China Petroleum & Chemical Corp raised $23 billion in bond sales in April, an increase of 141 percent from a year earlier, according to data compiled by Bloomberg. With additional $8.9 billion issuance so far in May, the sales this year totaled $69 billion, representing 71 percent of the record $98 billion in 2016.
Moody’s lowered China’s rating to A1 from Aa3 on Wednesday, citing a worsening debt outlook. Moody’s also downgraded the ratings of 26 non-financial corporate and infrastructure government-related issuers by one level. China’s Finance Ministry blasted the move as “absolutely groundless,” saying the ratings company has underestimated the capability of the government to deepen reform and boost demand.
“The economy is dependent on policy stimulus and with that comes higher leverage,” Marie Diron, associate managing director, Moody’s Sovereign Risk Group, said on Bloomberg Television after the announcement. “Corporate debt is really the big part.”
Market reaction has been muted. The yield premium on investment-grade notes from Chinese firms over government securities rose one to two basis points Wednesday, according to credit traders who aren’t authorized to speak publicly. Those spreads had already increased 10 basis points this quarter to 268.3, up from a decade-low of 257 in March, according to JPMorgan Chase & Co. indexes.
For major Chinese airlines, every percentage-point increase in average borrowing costs can cut net profit by 5 percent to 9 percent, said Crucial Perspective’s Png. For shipping companies, cuts to net profit may reach 15 percent to 30 percent.
Hainan Airlines, controlled by conglomerate HNA Group Co., plans to buy 19 Boeing aircraft, using the proceeds of a convertible bond sale of up to 15 billion yuan ($2.2 billion), according to a statement to the Shanghai Stock Exchange on May 19. HNA itself has been one of China’s most acquisitive companies, with more than $30 billion worth of announced and completed deals since 2016.
Aircraft- and ship-leasing companies like COSCO Shipping Development Co., China Development Bank Financial Leasing Co. and China Aircraft Leasing will also “try to pass on their higher financing cost to the airlines and shipping companies via higher aircraft and ship leasing rates,” Png said.
Some of the country’s biggest companies, including China’s three major state-owned airlines, have been reducing their dollar debt exposure and borrowing more onshore. Sales of yuan bonds by Air China Ltd., China Eastern Airlines Corp. and China Southern Airlines Co. jumped more than threefold last year to 135.4 billion yuan, according to data compiled by Bloomberg.
Air China said the carrier hasn’t issued U.S. dollar bonds overseas for a while and its aircraft leasing and buying isn’t funded by the securities. Representatives for China Eastern, China Southern and Cosco didn’t respond to requests seeking comment, while a representative for China Aircraft Leasing said the rating downgrade would have no impact on the lessor.
Starving for yields, investors have been scooping up the Chinese dollar bonds. The yields on the corporate dollar-denominated bonds have dropped to 5.05 percent, from 5.18 percent at the end of last year, according to JPMorgan. In comparison, China’s five-year AA rated onshore bonds increased to 5.73 percent from 4.63 percent, according to Chinabond data.
Still, some high-leveraged firms may be affected by Moody’s downgrade. Yields on bonds sold by Xinjiang Guanghui Industry Investment due in 2020 rose six basis points to 8.72 percent today, according to data compiled by Bloomberg.