Bloomberg News

Corporate Yield Gap Shrinks as Lending Curbs Ease: China Credit

October 30, 2011

Oct. 31 (Bloomberg) -- Chinese companies’ borrowing costs in yuan are sliding at a record pace relative to the government’s as lending curbs are relaxed to combat a slowdown in Asia’s largest economy.

The difference between yields on 10-year local-currency notes issued by top-rated companies and sovereign debt narrowed 35 basis points since September to 192, poised for the biggest monthly drop in Chinabond data dating to September 2007. The gap reached a record 236 on Oct. 11. The extra yield demanded to hold similar-maturity U.S. corporate notes instead of Treasuries shrank 54 basis points to 155, data compiled by Bloomberg show.

Premier Wen Jiabao said last week that the government will fine-tune economic policy as needed, fueling speculation two years of monetary tightening will be unwound as inflation slows. Companies are taking advantage of falling borrowing costs to sell more debt, with October issuance of 302 billion yuan ($48 billion) on track to the highest total for a month since March, according to data compiled by Bloomberg.

“China’s inflation, the most important factor for the bond market, is no doubt on a slowing trend,” said Lu Xin, a fund manager at Everbright Pramerica Fund Management Co., whose Advance Income Bond fund A has handed investors a 2.7 percent return this year, the second-best performance among more than 160 bond funds tracked by Bloomberg. “There may be bigger declines in corporate bond yields from the beginning of next year as inflation trends down.”

Reserve Ratios

The inflation rate was 6.1 percent in September, down from a three-year high of 6.5 percent in July. The People’s Bank of China raised the amount major banks must keep in reserve to a record 21.5 percent from 17 percent in the past year to help rein in consumer-price gains, with the most recent increase taking effect in June. The ratio for smaller lenders was boosted by a similar amount to 19.5 percent, while benchmark interest rates were raised five times since September 2010.

The nation’s gross domestic product climbed the least in two years in the third quarter, export growth was the smallest in seven months in September and expansion in M2, the broadest measure of money supply, was the slowest in almost a decade, official figures show.

The government relaxed lending curbs for small companies this month and the banking regulator indicated last week that local authorities’ financing units may be able to extend loan repayments. The Finance Ministry approved direct bond sales by the cities of Shanghai and Shenzhen on Oct. 20 as well as the provinces of Zhejiang and Guangdong, making it easier for their financing arms to refinance debt.

Yields Tumble

Regional governments in China set up companies to fund the construction of roads, sewage plants and subways after they were barred from issuing bonds and obtaining bank loans directly under a 1994 budget law. A June report by the National Audit Office said there were more than 6,500 entities with debt of 10.7 trillion yuan at the end of 2010, 42 percent of which would fall due in 2011 and 2012.

The yield on China’s top-rated 10-year corporate debt tumbled 42 basis points, or 0.42 percentage point, this month to 5.71 percent, Chinabond figures show. Yields on similar-maturity government bonds declined seven basis points to 3.79 percent.

Guotai Junan Securities Co. and Mizuho Securities Asia Ltd. predict the central bank will cut reserve-requirement ratios for small- and medium-size banks before the end of this year to help bolster economic growth. Mizuho forecast inflation may slow to around 4 percent at the end of this year and Guotai Junan said it may decelerate to 4.2 percent.

Financial Bonds

A preliminary index of purchasing managers released by HSBC Holdings Plc and Markit Economics on Oct. 24 showed China’s manufacturing may expand in October for the first time in four months. The economy grew 9.1 percent in the third quarter after expanding 9.5 percent in the second.

Banks will be allowed to sell financial bonds to help fund increased lending to small firms, the China Banking Regulatory Commission said on Oct. 25. The Ministry of Industry and Information Technology said on Oct. 26 it will work with other agencies to assist small businesses facing difficulties.

“All those monetary policy fine tunings and measures to support smaller firms will help China’s economy to rebound in the first quarter of next year,” said Shi Lei, head of fixed- income research at Ping An Securities Co., a unit of the nation’s second-biggest insurance company. Gross domestic product will climb between 8.5 percent and 8.8 percent this quarter, and by 9 percent in the first three months of 2012.

Left Behind

The economic outlook is spurring demand for top-rated corporate bonds. The Railways Ministry, the biggest seller of the securities in 2011, sold 10 billion yuan of seven-year notes on Oct. 26, drawing bids for 17 times the amount on offer, according to Chinabond. The so-called bid-to-cover ratio was 2.8 times at the ministry’s previous sale of debt of that tenor on Oct. 12.

Lower-rated bonds are being left behind in this month’s rally, with the difference in yield between five-year AAA notes and similar-maturity A-rated debt widening 79 basis points to a record 407, Chinabond data show. A-rated debt is the sixth- highest investment grade at Dagong Global Credit Rating Co., one of China’s official ratings firms.

“Investors are still concerned about low-rated bonds’ credit risks because the problem with local-government financing vehicles hasn’t been solved yet,” said Lin Hongjun, a Shanghai- based bond fund manager at Bank of Communications Schroders Fund Management Co., which oversees about 49 billion yuan. “The gap between high-rated and low-rated bond yields may widen further.”

Default Swaps

The cost of insuring Chinese sovereign bonds against non- payment tumbled this month by the most since March 2009. Five- year credit-default swaps on the notes fell 81 basis points to 118 basis points, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

The yuan has strengthened 0.5 percent in October to 6.3512 per dollar in Shanghai, according to the China Foreign Exchange System. It was 0.1 percent stronger today as of 10:58 a.m. local time.

Ping An’s Shi favors bonds rated AA+ or higher and predicts yields on such securities maturing in five-, seven- and 10 years will decline another 40 basis points to 50 basis points before the end of December. Short-term bond yields won’t drop further until the central bank cuts reserve-requirement ratios for smaller banks, a move anticipated by year-end, he said.

Companies need to issue longer maturity debt because these bonds are exposed to less risk as the trend of moderating inflation becomes more certain, said Everbright Pramerica Fund’s Lu.

--Judy Chen. Editors: James Regan, Sandy Hendry

To contact Bloomberg News staff for this story: Judy Chen in Shanghai at

To contact the editor responsible for this story: Sandy Hendry at

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