REPEAT:MNI China Money Week: Corp Bonds in Favor as Yields Woo

Repeats Story Initially Transmitted at 08:01 GMT Nov 10/03:01 EST Nov 10

--Spreads Between AA Rated Corporate Bonds and 5-Year CGBs Narrow 

     BEIJING (MNI) - In a reversal of Chinese market sentiment earlier this

year, the outlook for highly rated Chinese corporate bonds has improved

significantly, as investors turn to these issues after the recent sell-off in

Chinese government bonds significantly narrowed their spread with corporate

issues. 

     But investors are tending to favor higher-rated corporate bonds -- AA or

above -- given concerns about default risks posed by lower-rated companies. 

     China's corporate bonds have so far managed to escape the recent drubbing

seen in government and policy-bank bonds. Investors have preferred to hold on to

the less liquid higher-yielding securities to improve their returns and because

a big-scale sell-off of corporate bonds is seen as unlikely to happen in the

near future.

     Holders of riskier corporate bonds have had their confidence buoyed by the

country's resilient economic performance, which has boosted company earnings and

made it less likely that bond issuers will default. They are also continuing to

bet that the government will step in to bail out local government financing

vehicles that threaten to or actually default on their bonds. 

     Yields on benchmark 10-year government bonds have surged over the past

month, breaking through the 3.7% mark for the first time since April 2015 and

rising last week to within a whisker of 4%, a level not seen since October 2014.

The yields on the five-year CGB jumped as high as 3.9203%, the highest since

September 2014.

     In the interbank market, the spread between five-year AA rated corporate

bonds and five-year CGBs narrowed to 147 basis points on Wednesday, the smallest

since December last year, from 171 basis points on Oct. 9, when the market

reopened after the week-long National Day holiday. An announcement by Dandong

Port Group on Oct. 30 that it had failed to meet a demand for early repayment of

a CNY1 billion bond did little to sour the mood. 

     Corporate bonds have come back into favor after being dumped by investors

earlier in the year as financial regulators tightened the screws on investment

in wealth management products and the market become increasingly concerned about

the risks of default. From April 7 to May 22 this year, five-year CGB yields

rose around 63 basis points, and the spread between AA rated corporate bonds and

five-year CGBs widened by 15 basis points to 191 basis points, with the gap

widening even further to 208 basis points in early June. 

     "Corporate bond yields rose a lot in April as the deleveraging campaign

caused banks to pull out of their entrusted investment products," a

Beijing-based bond trader at a commercial bank told MNI. "Many funds had to sell

their assets, which comprised mostly higher-yielding corporate bonds."

     With the regulatory tightening temporarily over for now, a brighter

earnings outlook and fewer concerns about defaults, "funds are happier to hold

corporate bonds and collect the coupons as they wait for a new dawn for the bond

market," the trader said. 

     Many funds have been attracted to corporate bonds as they seek to improve

returns to their clients. 

     "Bond funds' investment returns were not very good in the first half of the

year so they have been under pressure to earn better returns in the second half

of the year," Li Qilin and Zhong Linnan, analysts at Lianxun Securities, said in

a report last week. "Investing in corporate bonds is a good strategy because

they pay high coupons." 

     But such a strategy also carries risks, as corporate bonds traded in

China's interbank market suffer from poor liquidity and are difficult to sell in

a hurry, the analysts noted. 

     Funds need to be mindful of the structure of their liabilities, they said,

recalling the mini panic back in April that forced many funds to dump their

corporate bonds. But they pointed to two factors that suggest current conditions

are more favorable.  

     Since August, yields on negotiable certificates of deposit (NCD) have not

risen significantly, suggesting financial firms' liabilities side is more

stable. Their research and surveys also show that banks have not withdrawn

significant amounts from asset management products as they did earlier in the

year. 

     The unexpected strength of the Chinese economy shown in recent economic

data, which is generally bad news for government bonds, is good news for

companies and for corporate bond holders. 

     "The economy's resilience, rapid expansion of credit and higher producer

prices are all contributing to an improvement in corporate fundamentals," Qin

Han and Gao Guohua, analysts at Guotai Junan Securities, said on Monday. "Credit

risks are not deteriorating."

     Many traders see little chance of a correction in the corporate bond market

as a whole in the short term, although they say low-rated bonds and companies in

out-of-favor sectors could be vulnerable if concerns about defaults start to

grow. 

     "Generally speaking, two things will trigger a sell-off of corporate bonds:

market expectations of an increased risk of defaults or some serious problem for

funds' liabilities, such as a mass exodus of funds from banks' asset management

products or tighter regulation, which is what happened in April," the Beijing

bond trader said.  

     A Beijing-based manager at a commercial bank in Beijing told MNI he expects

to see diverging fortunes for corporate bonds. "Highly rated bonds will do fine,

but the risk for low-rated bonds is significant and I wouldn't be surprised to

see some steep price declines."

     Analysts at China Merchants Securities said that in the wake of the Dandong

Port Group default, bonds issued by privately owned companies in particular are

vulnerable, especially those with high debts and poor profitability and which

have bonds maturing in the near future. 

     Although the market has been anticipating more bond defaults this year

after the government pledged to end bailouts and let zombie companies fail, the

reality has been the opposite. Data from Wind Information show that there have

been 36 bond defaults so far this year, compared with 78 for the whole of 2016

and 23 in 2015.

     Local governments have also been stepping in to organize rescues for many

companies that have failed to repay their bonds, reinforcing the market's belief

that despite their pledges, the authorities won't tolerate defaults.

     That partly explains the muted impact on the market of Dandong Port Group's

announcement last week that it couldn't repay bondholders. An official from the

company told Chinese media that the Liaoning and Dandong governments had stepped

in to broker a deal that would enable the port to meet its obligations. 

     The fact that the port industry is a key sector dominated by state-owned

enterprises and is being supported by the central government through a

consolidation strategy also helped. The spread between bonds issued by companies

in the port industry and corporate bonds with the corporate bonds actually

narrowed 6 basis points from Oct. 30 to Nov. 2, according to Zhongtai

Securities.

     Other industries haven't been so lucky. Aluminum conglomerate Qixing Group

failed to repay loans in March, triggering a rout in bonds issued by steel giant

Hongqiao Group, which had guaranteed the loans, with the sell-off spreading

through the sector. Spreads on bonds issued by non-ferrous metals companies and

corporate bonds widened from 82 basis points to 144 basis points in four days,

according to Zhongtai Securities.

     "Port corporate bonds always have a high rating and the yields are quite

stable, as the port industry is developing steadily and a large percentage of

those bonds are issued by state-owned enterprises," Qi Sheng and Hu Yushuang,

analysts with Zhongtai Securities, said in a report on Monday. "As long as

Dandong Port's default doesn't send out a negative signal that triggers concern

about the port industry as a whole, port industry bonds will be fine."

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