Two-tier credit

The central bank is watching...

In terms of size, the Chinese bond market seems to be growing at a healthy pace. Last week, Securities Daily reported that 28 brokerages have underwritten 106 bonds year-to-date, raising a combined Rmb190.5 billion ($30.23 billion), 159% more than in the same period last year. The average deal size also grew to Rmb1.8 billion, from Rmb1 billion over the same timeframe.

But this does not mean that debt capital is being evenly distributed across borrowers. Concerns are also rising over the possibility of a default, which is having an impact on where investors are putting their cash.

At the forefront of the problem is Shandong Helon, a fibre firm that looks as though it might be the first issuer in China to default on a corporate bond. The company has lost its investment grade credit rating and, as of mid-February, it had missed Rmb526 million in repayments. The fear now is that it might not honour repayment of a Rmb400 million bond scheduled to mature next month.

China’s first default on domestic debt would shock the market. If it were to happen, investors will no longer be able to rely on the assumption that the government will step in to prevent the worst from happening, especially as Shandong Helon is a state-owned company.

The result, according to HSBC research, is that “a flight to quality” is already underway. This can be seen in diverging credit spreads. Since late last year, spreads on bonds with a double A rating or above (in other words, companies with good credit standing) have tightened, while the spreads on bonds with lower ratings are 40% higher than in 2008, when they reached their previous high.

This is fostering a two-tier bond market or – as HSBC puts it – market of “the credit haves versus the have-nots”.

The ‘haves’ are typically entities owned or sponsored by the government. They now account for more than 85% of bonds issued and pay around 300bps less to borrow than their less privileged counterparts.

The ‘have-nots’ are more likely to be privately-owned, usually small and medium-sized enterprises (SMEs), or are backed by poorer local governments, including local government financing vehicles.

Of course, many of these ‘have-nots’ are in desperate search of funding, with private sector companies in general still facing a struggle to secure financing compared to their state-owned peers.

HSBC believes that while the credit markets remain risk averse to this group of firms, the banks will have to step in to fill the gap.

“Despite their stretched levels of capital, banks are likely to lead the way in lending to weaker borrowers such as SMEs and LGFVs from less developed areas until the credit crunch in the capital markets eases.”

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