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China Credit Calm Masks Growing Risks in $5 Trillion Market

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China Credit Calm Masks Growing Risks in $5 Trillion Market

(Bloomberg) -- While corporate-debt markets shut down for issuers in the U.S. and Europe for a stretch in February, with investors spooked by the economic hit from the coronavirus, China had its busiest month on record.

Optimism about Chinese policy makers providing abundant liquidity and spending has helped support the country’s $4.5 trillion corporate-debt market. (It also explains the recent outperformance of Chinese stocks compared with global peers.) But leveraged borrowers, particularly in the private sector, face the same pressures that propelled two record years of defaults in 2018 and 2019.

“Although the overall condition looks stable, there is a strong market preference towards issuances by financial institutions and public firms,” Alicia Garcia Herrero, chief Asia Pacific economist at Natixis SA, wrote in a note Monday. The coronavirus shock “pushes private firms deeper in the mire,” and without an improvement in market sentiment, the central bank may need to strengthen support, she said.

The following are some key indicators that market participants are watching for signs of stress:

Defaults Worsening

The pace of delinquencies is running at a record so far this year. After a business unit of a top Chinese university defaulted this quarter, there’s increasing scrutiny around the level of support that even state-linked firms can expect to receive.

Refinancing Pressure

Nearly half of all China’s stressed dollar debt -- bonds yielding at least 15% -- come due over the next 12 months. Some $9.4 billion needs to be paid off or refinanced. Market volatility is likely to increase around periods with big maturities, analysts say.

Stressed Pool

The pool of stressed debt remains elevated this quarter. The value of China dollar bonds yielding at least 15% has held at a weekly average of $20.2 billion so far this year. Any climb past December’s record high of $25.6 billion would signal expanding risks.

Offshore Property Debt

Property companies dominate issuance in China’s high-yield offshore bond market. They borrowed a record $25.8 billion so far this quarter, even with new regulations aiming to restrict the industry’s leverage. As the virus continues to pummel profits across the nation, the ability of developers to access the market will be a key indicator of liquidity and refinancing risk. With over 100 of China’s smaller homebuilders already bust, consolidation is looking increasingly likely.

Domestic Premiums

The spread between China’s AAA rated onshore corporate bonds and those with AA grades -- considered as junk -- has tightened, while yields for both continue to decline. Five-year premiums for the lower-rated notes shrank to their lowest levels since 2018, a sign of relative insulation from panic-driven sell-offs elsewhere as domestic investors continue to chase yields. Any change in that dynamic bears watching.

Offshore Junk

Yields of speculative-grade dollar notes jumped the most in five months after the oil-market crash triggered volatility across markets on Monday. Borrowing costs still remain well below 2018. Again, any sustained change would signal a shift.

Read more: Why China’s Government Is Letting Wave of Bond Defaults Just Happen

Sovereign Spike

The cost of insuring China against the risk of default saw its biggest jump in years on Monday, before retreating some later in the week. That could speak to the rising expectation of authorities boosting borrowing to aid the economy, come to the rescue of troubled borrowers, or a combination of both.

“We would expect Chinese CDS levels to stay elevated or even increase depending on dollar liquidity pressures, exacerbated by global recession risks,” said Wei Liang Chang, a macro strategist at DBS Bank Ltd.

The Virus

While increasingly China looks to have contained the coronavirus, that’s not yet the case abroad. If major economies like the U.S. and Japan start widespread and prolonged shutdowns, that threatens to worsen the already-serious near-term blow to China’s economy. And that, in turn, would strain revenues and credit quality in the Chinese debt market.

(Updates data in 5th, 6th and 7th chart; updates total 1Q property bonds in 8th paragraph)

--With assistance from Matt Turner and Helen Sun.

To contact Bloomberg News staff for this story: Rebecca Choong Wilkins in Hong Kong at rchoongwilki@bloomberg.net;Molly Dai in Singapore at bdai13@bloomberg.net;Yuling Yang in Beijing at yyang329@bloomberg.net

To contact the editors responsible for this story: Shen Hong at hshen87@bloomberg.net, Christopher Anstey, Ravil Shirodkar

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