Chinese companies’ dollar debt is handing investors the biggest losses in almost three years as concern bad loans will climb cools appetite for the securities amid signs the global recovery is losing steam.
The notes fell 1.5 percent in August, the most since global credit markets seized up in October 2008 following the collapse of Lehman Brothers Holdings Inc., according to HSBC Holdings Plc’s Asian U.S. Dollar Bond Index. Only India’s debt performed worse among issuers from Asia’s 10 biggest economies excluding Japan and Taiwan. Bonds sold by firms in Singapore, the only regional economy to be rated AAA by the three largest ratings companies, gained 1.3 percent, while U.S. Treasuries rose 2.8 percent.
Chinese companies have sold a record $33 billion of dollar- denominated bonds this year as the yuan strengthened 3.4 percent versus the greenback and domestic interest rates were raised three times. The cost to protect the Asian nation’s sovereign debt against default jumped the most in two years in August amid fears the banking system will need to be bailed out as loans to local governments turn sour.
“There is growing concern about the financial standing of Chinese corporations amid a tight credit environment,” said Takahide Irimura, head of emerging-market research in Tokyo at Kokusai Asset Management Co., which manages about $60 billion of assets. “Also, investors are generally becoming more risk averse.”
Evergrande Bonds Fall
Dollar-denominated bonds issued by Evergrande Real Estate Group Ltd. (3333), China’s second-biggest developer by sales, dropped in August by the most in data going back to June 2010. The yield on the 13 percent notes due January 2015 climbed 317 basis points, or 3.17 percentage points, to 14.92 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Cnooc Ltd. (883)’s 4.25 percent bonds due January 2021 rose last month, pushing their yield down 35 basis points to 3.85 percent. Industrial & Commercial Bank of China (601398) Ltd.’s 5.125 percent debt due November 2020 fell, with the yield on the securities climbing 10 basis points to 5.17 percent.
China’s largest offshore oil explorer, Cnooc is rated Aa3 by Moody’s Investors Service, the fourth-highest of 10 investment grades. Industrial & Commercial Bank, the world’s biggest lender by market value, is rated three steps lower at A3, while Evergrande’s B2 rating is five levels below investment grade.
Credit-Default Swaps
The average yield Chinese companies pay to borrow in dollars reached a 14-month high of 5.69 percent on Aug. 25, 35 basis points more than it was at the start of last month, an HSBC index shows. The rate has since declined to 5.44 percent as better-than-expected U.S. manufacturing and consumer spending data damped concern the world’s biggest economy is headed for a recession. The securities, which tumbled 12 percent in October 2008, advanced 0.1 percent since the end of August.
Five-year credit-default swaps for China’s debt surged 21 basis points to 108 basis points last month, the biggest increase since August 2009, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. They touched 123 basis points on Aug. 26, the highest level since May 2009, and were up seven basis points to 115 on Sept. 2 in New York.
Contracts for Brazil and Russia were 143 basis points and 187, respectively, at the end of last month. A basis point equals $1,000 annually in a contract protecting $10 million of debt. The derivatives are used to insure debt against non- payment and traders use them to speculate on credit quality.
Bailout Risk
Fitch Ratings lowered its outlook on China’s sovereign AA- local-currency rating to “negative” from “stable” on April 12 because of the risk banks will need to be rescued. Insufficient data about the debt of China’s local governments is a “weakness,” Andrew Colquhoun, Asia-Pacific head of sovereign ratings at Fitch, said last week in Beijing.
Policy makers have told lenders to set aside more cash to address concern that the $1.7 trillion in liabilities accrued by regional administrations building roads and other infrastructure will trigger the nation’s third banking bailout in less than two decades. Chinese banks’ non-performing loan ratio fell to 1 percent in the second quarter, from as high as 5.8 percent in the first quarter of 2008, according to data on the industry regulator’s website.
Premier Wen Jiabao said on Aug. 31 that the country’s top priority is stabilizing prices and the government doesn’t plan to alter the direction of economic policies. The yuan gained 0.9 percent against the dollar in August, the biggest advance of 2011, as data showed inflation reached a three-year high of 6.5 percent in July. The currency declined 0.02 percent to 6.3826 per dollar on Sept. 2.
Fed Stimulus
The Federal Reserve cut its benchmark interest rate to a maximum of 0.25 percent in December 2008 and on Aug. 9 pledged to maintain record-low borrowing costs through mid-2013 to support the U.S. recovery. The monetary authority has also announced two rounds of bond purchases to help the economy, a policy known as quantitative easing that boosts the supply of dollars. Chairman Ben S. Bernanke said on Aug. 26 that further stimulus measures are possible. The next policy review concludes Sept. 21.
“If the Fed does have a QE3, or even hint of a QE3 coming soon, that could potentially cause the credit markets to perform better going ahead, including dollar debt,” said Wee-Ming Ting, the Singapore-based head of Asian fixed-income at Pictet Asset Management, which oversees $18.2 billion in emerging-market debt. “It’s important to be not too negative.” He declined to disclose whether his fund holds Chinese corporate dollar debt.
Accounting Concerns
The securities lost 3.6 percent in August, the biggest drop since October 2008, according to JPMorgan Chase & Co. indexes. Notes sold by corporate issuers in India lost 2.2 percent, those in Brazil fell 1.8 percent and Russian debt declined 1.3 percent, the data show.
Investor appetite for foreign-currency bonds of Chinese companies may remain weak “for the time being” as concern persists over the reliability of their financial reporting, said Kokusai’s Irimura. Sino-Forest Corp.’s shares were suspended from trading in Toronto on Aug. 26 after the Ontario Securities Commission said directors of the tree-plantation company may have engaged in acts “related to its securities” that they “knew or should have known” perpetuated a fraud.
The world’s fastest-growing major economy is also showing signs of cooling. Manufacturing growth held near a 29-month low in August, according to data released last week by the China Federation of Logistics and Purchasing. A separate HSBC report suggested output contracted for a second month. UBS AG, Morgan Stanley and Deutsche Bank AG lowered economic growth forecasts for China in August.
“Activity data out of China has not been encouraging, weighed down by lower external demand,” said Krishna Hegde, Asia credit strategist at Barclays Capital in Singapore. “The softening in the economy is also a negative factor for bonds of Chinese industrial firms.”