MNI China Money Week: Heavyweight CDB Wades In to Calm Market

--Policy Bank Conducts Bond Exchange, Omits 10-Year Bond From Weekly Auction

     BEIJING (MNI) - China's biggest policy bank has been using its weight and

influence in the bond market to try and calm sentiment and halt the rout that's

seen yields on benchmark 10-year government bonds jump 15 basis points in three

weeks and yields on its own 10-year bonds surge past 5% for the first time since

2014.

     China Development Bank (CDB), one of the most prolific issuers of bonds in

the interbank market, alerted the market last week that it would not offer

10-year maturities in its normal weekly bond auction this week, the first time

it had suspended the issuance of its 10-year bond in more than three years. The

move suggested the bank took the view that with yields jumping, the cost of

issuing a 10-year bond would be too high, a Beijing-based bond trader at a

brokerage told Market News International. 

     CDB bond issues have a big impact on the bond market because of their huge

scale. So far this year, CDB has issued a total of CNY1.57 billion of bonds,

accounting for more than 50% of the total issuance of policy bank bonds, and

accounting for almost 10% of total bond issuance, excluding negotiable

certificates of deposit (NCDs) and commercial paper.

     Analysts at brokerage China Securities estimate that the rate of return on

CDB 10-year bonds is probably between 4.44% to 4.67%, lower than the current

10-year CDB bonds yield, which was 4.8155% on Thursday. At its peak last week,

the CDB yield vaulted the psychologically important 5% level. 

     "As the CDB's financing costs now exceed the return it's making on its

loans, it will likely cut back on new financing and bond issuances," the China

Securities analysts wrote in a report on Tuesday. "The decreasing supply of

bonds should stop yields from rising."

     CDB also carried out a bond exchange at Tuesday's auction, a move analysts

said was aimed at calming the market and easing downward pressure on prices of

its 10-year issues, the type of bond whose yield has risen the fastest and is

the most liquid. CDB bought back actively traded 10-year bonds, maturing on Aug.

24, 2027, while issuing additional amounts of its existing one-year CDB bonds,

which mature on Jan. 23, 2018.

     "CDB's buyback of 10-year bonds and its suspension of new 10-year bonds

this week should help to alleviate selling pressure and lift bond market

sentiment," analysts at China International Capital Corp. wrote in a report on

Monday. "It is also a warning to any market participants shorting 10-year CDB

bonds." 

     Since October, yields on 10-year CDB bonds have risen more rapidly than

yields on Chinese government bonds with the same maturity. The spread has

widened from 57.3 basis points on Oct. 9, when markets re-opened after a

weeklong public holiday, to 96 basis points on Nov. 23, the widest gap since

2014, before easing back to 92.5 basis points on Thursday. 

     The jump in the premium of policy bank bonds over government debt indicated

short-selling pressure, some analysts said. 

     "There is normally a liquidity premium between bonds with the same

maturity, but in a bear market, bonds with better liquidity will normally see

yields go up more slowly than those with poor liquidity, so the liquidity

premium will rise," Dong Dezhi, an analyst at Guosen Securities, said on

Thursday. "But since November, the more liquid 10-year CDB bonds have seen their

yields rise more rapidly than less liquid bonds, which indicates there are

investors actively short-selling the actively traded CDB bonds."

     Other analysts are critical of this speculation, arguing that bond lending

data did not support it.

     "The increase [of bond lending in November] was mainly due to greater

borrowing by commercial banks, which was very likely caused by higher funding

costs like negotiable certificates of deposit, which caused [the banks] to

borrow money using other methods," analysts at Guotai Junan Securities wrote in

a report. "As a result, commercial banks have been borrowing bonds to use as

collateral to borrow money, which can be cheaper than issuing NCDs. So the

increase in the volume of lending is not necessarily evidence of short selling."

     After Tuesday's auction and bond exchange, the yields on the most actively

traded 10-year CDB bonds fell from 4.9150% at Tuesday's close to 4.8150% on

Thursday.

     There was huge investor demand Tuesday for CDB's exchange of 10-year CDB

bonds to a soon-to-mature one-year CDB bond, with bids 5.41 times the volume of

bonds on offer, indicating the market still believes the outlook for bond prices

is bleak. 

     "The motivation for investors to take part in the bond swap was their

pessimism over the outlook for the bond market. If they expected 10-year CDB

bond prices to go up, they certainly wouldn't have participated," analysts at

Hua Chuang Securities said on Wednesday. "The bond swap will help investors

reduce their paper losses. Most investors, especially short-term traders, are

nursing losses on their 10-year CDB bonds, which will be recorded as paper

losses and show on their balance sheets. But if they swap 10-year CDB bonds for

one-year bonds and hold them until maturity, it will cut their losses."

     CDB's actions this week may have helped stabilize the bond market rout, but

traders say they will have little lasting impact unless the bank indefinitely

suspends 10-year issuance to lower the supply of new bonds. 

     "If CDB is only going to suspend a 10-year bond issuance once, which seems

the most likely scenario, then it's not going to do much to push CDB bonds

yields lower in the long term," another Beijing-based trader at a securities

company said. "I suspect the rally of CDB prices will not last long."

     If CDB is only concerned about its cost of funding, then it's unlikely to

keep suspending 10-year bond sales, according to some analysts. 

     Hua Chuang Securities estimates CDB's average cost of funds for 2017 will

be around 3.69%, lower than the 4.4% of average loan interest rate in 2016, as

disclosed in its annual report for that year. 

     "The recent increase in the CDB bond primary market rate isn't going to

have a significant influence on the bank's profits, so investors should not

expect that CDB will suspend its bond issuance to any significant extent," Hua

Chuang Securities said. "Neither should investors use CDB's actions as the basis

for predicting that CDB bond yields have peaked."

     Policy bank bonds aren't powerful enough to influence the direction of the

bond market other than in the very short term, analysts say. 

     "The impact of the CDB's actions is mainly on short-term market sentiment

rather than on the fundamentals that are driving the market," analysts at Guotai

Junan Securities said. "The bank's adjustment of its bond issuance is more a

result of rising bonds yields, and is not a strong enough factor to push yields

lower."

     Analysts at Hua Chuang Securities said the recovery in market sentiment

this week will only bring about a short-term rebound in the bond market. 

     "What CDB has done this week will alleviate short-selling pressure, but

further out all it can do is help to slow the downward trend of bond prices,"

Hua Chuang analysts said. "Given there's no real change in economic

fundamentals, regulation remains tough and monetary policy remains neutral, the

bond market will continue to fall and the short-term rebound will not last

long," they said, estimating that yields on 10-year CDB bonds are unlikely to

dip below 4.7% and those on 10-year China government bonds will remain higher

than 3.9%.

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

--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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