MNI CHINA MONEY WEEK: Bond Defaults Weigh On Risk Sentiment

     BEIJING (MNI) - Rising concerns over China corporate bond defaults and

rising U.S. treasuries yields have made investors cautious over the outlook for

the bond market, causing the yield curve to steepen this week.

     The spread between 1-year and 10-year CGB widened to 76.89 basis points on

Thursday from 69.47 basis points last Friday, partly caused by concerns for

lower U.S.-China yield spreads.

     Liquidity conditions have improved dramatically from the end of April,

driving down short-end yields. Despite of efforts by the People's Bank of China

to drain a net of CNY140 billion via its open market operations this week,

seven-day deposit repo rate and seven-day repo rate averaged 2.6859% and 2.8496%

respectively as of Thursday. 

     The possibility for liquidity to tighten as in April appears relatively

small, as regulators will ease the process for banks to comply with new asset

regulation rules. The late April liquidity position should be seen as an alarm

for financial institutions who relied too heavily on rolling over their

liquidity position daily.

--RISING DEFAULT CONCERNS

     Increasing defaults has certainly made investor sentiment more cautious.

One public-listed company, Kaidi Eco, defaulted on its medium-term notes on May

7, although Kaidi said it will try to pay back interest and principal within two

months. 

     Dunan Group, who owns two public-listed companies, also suffered from a

liquidity drought. It just avoided default and paid back short-term notes on May

9, but the market is still worried about its outstanding bond that matures later

this year, amounting to CNY6.3 billion in total.

     As regulators crack down on shadow banking and wealth management products

guaranteeing principal payments, which in the past provided funding to private

companies and local government funding vehicles, an upturn in defaults seems

likely.

     As a result, more private companies and LGFVs have found it more difficult

to get funding and their liquidity risks are picking up. This will further

dampen investor confidence about low-rated corporate bonds, triggering a

downward spiral. The willingness of investors to extend their portfolio duration

will also be impacted.

--OVERSEAS INVESTORS

     April data suggested overseas investors are still actively buying CGBs.

Outstanding CGBs held by overseas financial institutions increased to CNY780.8

billion in April, up from CNY712.1 billion in March.

     China is actively opening up its financial market to overseas investors.

Premier Li Keqiang announced Wednesday that China will grant Japan a CNY200

billion quota for Renminbi Qualified Foreign Institutional Investors (RQFII),

which enables Japan investors to invest in China's bond and stock markets.

     As domestic banks focus on dealing with the new asset regulation rules and

wealth management products will see a slowing pace of take up, natural domestic

demand for bond will stagnate. Overseas investors, in this case, could be the

balancing factor to keep bond yields at a relatively low levels and help lower

corporate funding costs, as promised in the April Politburo Meeting.

--AUCTION RESULTS

     This week's bond auctions showed a modest paring of demand in the primary

market, with some yields higher than bonds with same duration in the secondary

market. However, demand for seven-day CDB bonds issued on Thursday was extremely

strong, with some traders saying it was a sign banks are beginning to buy in

larger amounts as they think the current yield level is attractive.

                                   Issuance                            Secondary

               Issuance  Duration     Scale  Issuance  Bid/Issuance       Market

Bond Issuer        Date   (Years)     (Bln)     Yield         Ratio        Yield

--------------------------------------------------------------------------------

Agricultural

Development

Bank of China     May 7         2         4   4.0040%          4.65      4.1038%

China

Development

Bank              May 8         1       8.6   3.5227%          4.01      3.7040%

China

Development

Bank              May 8         3       9.1    4.137%          2.63      4.1758%

China

Development

Bank              May 8         5       8.3   4.2492%          3.13      4.3217%

China

Development

Bank              May 8        10        12   4.4358%          2.29      4.4514%

Agricultural

Development

Bank of China     May 9         1       8.4   3.5830%          2.49      3.7033%

Agricultural

Development

Bank of China     May 9         5         7   4.4096%          2.24      4.4464%

Agricultural

Development

Bank of China     May 9         7         4   4.5687%          3.48      4.5690%

Agricultural

Development

Bank of China     May 9        10         5   4.6500%          3.51      4.6495%

Ministry of

Finance           May 9         2      29.5   3.0551%          2.43      3.0794%

Ministry of

Finance           May 9         5        41   3.3491%          2.03      3.3331%

China

Development

Bank             May 10         7         4   4.5325%          5.00      4.5992%

Export-Import

Bank of China    May 10         1         3   3.7140%          2.44      3.7052%

Export-Import

Bank of China    May 10         3       5.3   4.2698%          2.49      4.3023%

Export-Import

Bank of China    May 10         5       5.6   4.4465%          2.18      4.4827%

Export-Import

Bank of China    May 10        10       4.7   4.6447%          3.69      4.6803%

Ministry of

Finance          May 11      0.25        10   2.6718%          2.26      2.7365%

Ministry of

Finance          May 11       0.5        10   2.9132%          2.54      2.8069%

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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