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--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
     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
     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
     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
     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%.
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