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China Default-Swap Bets at 14-Month High on Trust Flops

January 26, 2014

Credit traders have taken out the most protection on China’s debt in 14 months just as the world’s second-biggest economy faces a default test in its $1.7 trillion market for trust products.

The net notional amount of credit-default swaps outstanding on Chinese sovereign bonds totaled $9.125 billion on Jan. 17, the most since November 2012, according to weekly figures published by Depository Trust & Clearing Corp. December’s 12 percent jump to $9.066 billion was the biggest monthly gain since October 2011, the figures indicate. The cost of the contracts surged 25 basis points since Dec. 31, poised for the largest monthly increase since a record cash crunch in June.

Credit risk is mounting amid speculation a 3 billion-yuan ($496 million) trust product distributed by the nation’s biggest lender will fail to repay holders this week. Borrowing costs for debtors are also climbing as the government eases interest-rate controls. Local-government financing vehicles set coupons of more than 9 percent in two debt sales last week, levels not seen since at least 2012, according to Nomura Holdings Inc.

“Any news related to China can have sentiment impact on global risk assets and this is really the issue in the short term,” Damien Buchet, head of emerging-market fixed income in Paris at AXA Investment Managers, said by phone on Jan. 23. “This is the reason why some people are buying China CDS.” AXA manages 550 billion euros ($750 billion) globally.

Costlier Protection

Five-year credit-default swaps protecting against a default on Chinese government debt reached 105 basis points on Jan. 24 in New York, the most since Aug. 30, according to CMA prices. The cost is little changed today and set to climb for a second month, after almost halving to 65 from 121 in the August-November period.

The yield on the 4.08 percent note due August 2023 fell one basis point to 4.49 percent as of 11:12 a.m. in Shanghai, from yesterday when markets were open for an extra trading session before the week-long Lunar New Year holiday begins on Jan. 31. Ten-year bond yields surged 104 basis points in the second half of last year, touching a record 4.72 percent in November, ChinaBond data show.

Assets managed by China’s 67 trusts soared 60 percent to $1.67 trillion in the 12 months ended September, according to the China Trustee Association. The trust product maturing this week, known as Credit Equals Gold No. 1, was set up to lend money to a coal miner that subsequently failed.

Distributor Industrial & Commercial Bank of China Ltd. (1398), the trust issuer and the Shanxi provincial government may bail out investors, the Guangzhou-based Time-Weekly reported on Jan. 23. Shanxi’s financial office denied it would pay a 50 percent share of the debt, while ICBC Chairman Jiang Jianqing told CNBC in Davos, Switzerland that the incident will be a lesson on risk for investors.

S&P Warning

Standard & Poor’s expects the product to fail, according to a Jan. 24 statement in Hong Kong, and said any bailout by ICBC may trigger a review of its assessments of both the lender and China’s banking industry. “Chinese banks are unlikely to bail out high-yield wealth management products unless the banks happen to be the originator of the products,” Senior Director Qiang Liao wrote in the statement.

China’s 25.9 trillion yuan bond market is dominated by state-backed issuers and has yet to have its first default. As liabilities are rolled over or reorganized, a “debt snowball” threatens to trigger a financial crisis, according to Haitong Securities Co.


Liabilities at non-financial corporates may rise to more than 150 percent of gross domestic product in 2014, Haitong, China’s second-biggest brokerage, said this month. The amount owed by local government financing vehicles surged 67 percent from the end of 2010 to 17.9 trillion yuan as of June 30, according to an official audit released this month. Everbright Securities Co. estimates they will need to repay a record 299.5 billion yuan of bonds this year.

“If the market sees serious credit risks, local governments’ financing channels will be closed,” Xu Gao, chief economist at Everbright in Beijing, said in a Jan. 20 phone interview. “The consequence is not what top leaders can accept and would lead to a hard landing of the economy.”

S&P said it does not expect local-government bonds to default in 2014.

“Amid perceptions of growing financial risks in the country, the central government appears to be wary of destabilizing sentiment through major disruptions, such as a default,” Kim Eng Tan, an S&P credit analyst in Singapore, said in a Jan. 24 statement. “However, China’s creditworthiness could deteriorate if indebtedness continues to grow rapidly, including from local and regional governments.”

Strained Finances

More than 50 percent of the LGFVs do not generate enough cash to pay the interest on their debt and so rely on new borrowing and government subsidies to finance operations, Nomura estimated in September, adding that a 100 basis point increase in borrowing costs would boost the ratio by 10 percent.

“We continue to expect defaults to occur in the corporate, LGFV, and the shadow banking sectors in 2014,” Zhang Zhiwei, a Hong Kong-based economist at Nomura, wrote in a Jan. 22 report.

Citic Securities Co., China’s largest brokerage said losses on the Credit Equals Gold No. 1 trust product would have limited impact on China’s financial markets.

“It’s not like a default on the bond market,” Yang Feng, a Beijing-based bond analyst at Citic, said in a Jan. 20 phone interview. “I still don’t believe there will be any defaults on the bond market this year. The cost would be too high for local governments.”

To contact the reporter on this story: David Yong in Singapore at

To contact the editors responsible for this story: Sandy Hendry at; James Regan at

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