By Fiona Law
HONG KONG--China's stock market, its currency and economy all face pressure, and now those factors have some of the country's leading corporations paying a premium to borrow.
Global investors continue to flock to Chinese corporate debt as stocks have plunged, raising bond prices and thus lowering rates, but Chinese companies are paying higher interest rates to investors compared with corporate issuers elsewhere in Asia.
Investment-grade Chinese corporate bonds yield 1.92 percentage points above the benchmark 10-year U.S. Treasury note, compared with about 1.05 percentage points for counterparts in South Korea. High-grade corporate bonds in India are 1.86 points above Treasurys, while Malaysian debt is 1.37 points above Treasurys, according to a UBS analysis. The yield on the 10-year U.S. Treasury has dropped since mid-June, resulting in lower aggregate borrowing costs overall for Asian borrowers.
China bonds "have higher volatility with lots of supply," said Edwin Chan, UBS head of Asia credit research in Hong Kong. "People's expectation of more ongoing supply helps widen their credit spreads, too."
This year, Chinese companies have sold bonds valued at $73.8 billion denominated in U.S. dollars or euros, up 35% from a year earlier, according to data provider Dealogic, including investment- and non-investment grade.
Since mid-June, prices of U.S. dollar bonds issued by Chinese companies to overseas investors have risen about 0.6%, according to the J.P. Morgan Asia Credit Index, even as the Shanghai Composite Index has declined 28% in that time.
The performance for Chinese corporate bonds illustrates continuing global investor demand for a piece of the country's comparatively strong 7% economic growth and their confidence that many companies are robust enough to repay their debts. It also shows how China's bond issuers, including a rising number of smaller companies controlled by local governments instead of the central government, are paying for the privilege to raise money on international markets.
"Asia looks relatively stable and China looks even stronger," said Hayden Briscoe, Asia-Pacific fixed-income director at mutual-fund company AllianceBernstein Holding LP, which runs a Chinese bond fund with $630 million in assets. He said China faces no sovereign downgrade risk and limited likelihood its currency will fall significantly, which, he said, is unique among emerging markets.
China-based companies account for two-thirds of the investment-grade corporate debt sold in Asia this year outside of Japan, compared with about 60% last year. China's government is encouraging its companies to replace bank borrowing with more market-oriented financing, such as stocks and bonds. The most active bond issuers this year are some of China's largest state-owned companies, such as the parent of Hong Kong-listed oil producer China Petroleum & Chemical Corp., known as Sinopec, and lender China Construction Bank Corp.
A day after Chinese shares tumbled 8.5% on July 27, a bond from port operator China Merchants Holdings (International) Co. illustrated the added costs for the country's debt issuers. China Merchants sold $700 million in bonds at the same 3.5% yield on a $650 million bond sold a week earlier by Indian port operator Adani Ports & Special Economic Zone Ltd.
But the China Merchants issue was rated triple-B-plus by Standard & Poor's Ratings Services, two notches higher than the firm gave to the Adani bond. The grading meant that S&P viewed the Chinese company as better able to repay its bond, and it should have allowed China Merchants to borrow more cheaply than its Indian counterpart instead of at the same rate.
Global investor demand for Chinese bonds contrasts with broader concerns about the country's economic health that might be expected to limit interest in corporate debt. China's economy is expanding at the slowest pace in roughly a quarter-century, which could crimp corporate profit growth and prompt authorities to push the value of the yuan lower to boost exports, factors that could make it harder for companies to repay debt.
Also, the U.S. Federal Reserve may be readying an increase this year in interest rates for the first time in nearly a decade that could further drag on world-wide growth and make it more expensive for companies globally to borrow. And more Chinese corporate-bond sales may be on the way following stock-market turmoil that limits companies' ability to issue new shares, a wave of supply that could weigh on bond prices and push up yields, or the interest rates they pay to borrow.
Still, other factors could bolster the corporate-bond market. China appears on track to further lower interest rates, which could free up capital for companies to refinance their debts and reduce the likelihood of defaults. And the yield premium on Chinese bonds represents a cushion for investors if higher U.S. interest rates erode bond values, some analysts said.
"There are definitely some concerns about China's growth...but most companies have stable fundamental outlooks with good income," said Bryan Collins, who manages more than $5 billion in bond funds for Fidelity Worldwide Investment in Hong Kong.
He said money flowed into Fidelity's China bond funds even as stocks dropped in late June.
Chinese corporate-bond defaults are rare. But foreign investors got a taste of the risks this year when one of the country's developers, Kaisa Group Holdings Ltd., missed some bond payments, sending prices on its outstanding debt sharply lower.
One reason Chinese yields are higher compared with peers in Asia is that the companies are considered riskier.
Among new Chinese debt issuers this year that had investment-grade ratings, 26% carried the minimum triple-B rating, compared with 16% of investment-grade borrowers in 2012, according Harsh Agarwal, head of Asia credit research at Deutsche Bank AG.
Mr. Agarwal said many Chinese issuers would fall to junk ratings based on corporate fundamentals alone, particularly state-owned companies controlled by local governments. The investment-grade ratings result from the fact that the companies have government backing.
Beijing Capital Land Ltd., a property and water treatment business owned by the municipal government of Beijing, earned an investment-grade triple-B rating from S&P, which cited a "high likelihood" the local government would provide "timely and sufficient extraordinary support to the company in the event of financial distress." But without that support, S&P said, the company would be rated double-B because of its debt burden.
Write to Fiona Law at firstname.lastname@example.org