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Why bond market risks are on the rise

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He Qiaonv: bond difficulties

Two years, two very different endangered species. In late 2017, Chinese entrepreneur He Qiaonv pledged to give $1.5 billion of her fortune to protect some of China’s most fragile habitats and save the country’s vulnerable snow leopard population. The philanthropic world hailed the donation as the largest-ever personal contribution towards wildlife conservation.

But little did He realise that within six months, investors would be putting the company she derived her $3.6 billion fortune from onto the endangered list as well. For in China’s bond markets right now, finding a willing investor for lower rated credits is almost as difficult as spotting the elusive snow leopard.

He’s company, Beijing Orient Landscape, ran into trouble towards the end of May when it announced that it had only raised Rmb50 million ($7.8 million) out of a planned Rmb1.5 billion bond issuance. The firm’s stock lost a quarter of its value over the following week before it was suspended from trading on May 25 pending an announcement.

At its current level, the share price is still more than double where it was trading at in early 2016, when equity investors started buying into the company’s transformation from a landscape engineer to a much more broadly diversified company that has moved into water management and struck a large number of PPP (public-private partnership) deals with local governments.

Orient Landscape is just one of many companies that bond investors are concerned about as the government continues its deleveraging campaign across the economy. They have responded by sticking to higher-rated and supposedly safer state-owned companies with triple-A ratings (Orient Landscape has an AA+ rating from local agencies).

The company says it won’t have a problem paying back the Rmb2.9 billion of debt maturing this year, and CICC notes that most environmental service companies have “healthy” operating cashflow ratios. “Most private sector companies are having difficulties issuing bonds, but the fundamentals remain solid thanks to timely payment on PPP projects,” the securities house claims.

Dealogic figures show just how severe the drop-off in bond issuance has become. Chinese onshore issuers raised just $12.59 billion over the course of May. This represented just one quarter of the proceeds they raised during the same month last year.

On a net basis, issuance is now negative at a time when Rmb2.7 trillion in corporate debt is coming up for maturity in 2018.

Tightening macro conditions are leading to higher defaults and credit spreads are widening. As a result, double-A rated credits are now yielding about 225bp more than triple-A rated ones at the three-year part of the curve.

Defaults have grown sharply since 2014 when the government decided to enforce more credit discipline on the market by allowing the first corporate to default.

Defaults had risen to Rmb38.4 billion by 2017 but the figure might worsen this year, as a total of 11 companies and 19 bonds (amounting to over Rmb13 billion) were already in default by the end of May.

One company which seems likely to push the total higher is CEFC China Energy, whose chairman Ye Jianming disappeared in February amid reports that he has been put under investigation for economic crimes.

In May CEFC became the biggest corporate defaulter of the year (so far) when it failed to repay Rmb2 billion of principal on a short-term note issue. It has a further Rmb27.6 billion outstanding, of which Rmb8.1 billion falls due this year.

But the government is also moving to reassure the market. China Securities Journal, which is published by Xinhua, recently ran a front page editorial concluding that defaults will remain in the “controllable range”. Then last week the People’s Bank of China stepped in to ease liquidity pressures by adding lesser-rated corporate bonds (i.e. below triple-A) into its pool of eligible collateral for its medium-term lending facility. This stood at Rmb4 trillion in May, but analysts estimate it will be boosted by Rmb6 to Rmb10 trillion, of which Rmb7 trillion will come from the country’s outstanding AA+/AA bonds.


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