Money

In China, not all triple A rated bonds are created equal

Chinese credit rating companies are assigning more triple A bond ratings, a trend that has continued this year despite the coronavirus pandemic and increased borrowing by companies in the world’s second-largest economy.

As of mid-October, more than 18.3 trillion yuan, or $ 2.7 trillion, in outstanding yuan-denominated bonds issued by companies and financial institutions in mainland China had the highest possible rating of The country’s credit assessors, according to data provider Wind and asset director Invesco Ltd.

Triple A bonds currently represent 57% of all Chinese onshore corporate debt that is outstanding. The share of top-rated debt has increased in recent years. In 2015, about 37.5% of corporate debt in mainland China was rated triple A.

In the United States and many other countries, triple A corporate bond ratings are rare and have been assigned to the most financially sound issuers of debt with minimal risk of default. Microsoft Corp.

and Johnson & Johnson are the only US companies to achieve the coveted S&P Global Ratings rating. In the US dollar bond market, S&P has rated around 300 Chinese non-financial companies, rating them from simple A plus to triple C minus.

In China’s large domestic debt market, triple A ratings, mostly assigned by domestic assessors, are commonplace. S&P and Fitch have Chinese affiliates that rate a small number of Chinese institutions and they have also achieved a triple A rating. The rating scales and methodologies of their affiliates in mainland China differ from what companies use internationally.

China’s unique bond rating system poses challenges for international investors looking to enter the market or own global index funds that own domestic Chinese bonds, said Kate Jaquet, co-portfolio manager at Seafarer Capital Partners, a company based in Larkspur, California. investment firm.

“A rating scale like this is not healthy for a bond market,” she said.

Foreign investors have increased their holdings of yuan-denominated bonds, although their participation in the Chinese domestic bond market of $ 14.5 trillion is still low and they have, for the most part, stuck with public debt and the obligations of public development banks.

The tendency to issue more triple A ratings in China has somewhat shocked international investors and analysts. Businesses borrowed more during the pandemic, and some postponed paying back banks and investors after their income was hit. However, the Chinese economy has recovered faster than in much of the world; the country said this week that third-quarter GDP grew 4.9% from a year earlier.

Inside and outside

How the domestic credit ratings of some companies in China compare to their international ratings.

While bond defaults in China occur less frequently than in the United States, they have increased this year. Some companies have blamed lockdowns, business closings and a slowdown in economic activity caused by the spread of the coronavirus. Defaulters include heavily indebted real estate developers, manufacturers and conglomerates.

“The upward trend in ratings is clearly contrary to the general trend of credit risk in the Chinese corporate bond market,” said Logan Wright, director of research on Chinese markets at consultancy firm Rhodium Group. Elsewhere in the world, there have been numerous downgrades to corporate bond ratings, as economic downturns have squeezed the earnings of many companies.

Owen Gallimore, head of credit strategy at ANZ, said China’s onshore debt markets appear to have benefited from large amounts of cash injections from the country’s central bank during the pandemic. Generally speaking, Gallimore said he believes national ratings in China are not good measures of credit risk. A triple A rating “tells you whether the business is important or not,” he added, and the government is not expected to let state-owned companies and large politically connected companies fail.

Take the case of the China Evergrande group,

the country’s most indebted real estate developer and the biggest junk bond issuer in the Asian dollar bond market. Last month, Evergrande stock and bond prices plunged in value after documents released online indicated the company was in dire financial straits, with a deadline looming to either go public with a key subsidiary or repay debt. billion dollars to some investors.

On September 24, S&P changed its view of Evergrande to negative, saying it believed the group’s liquidity was weakening and that it was facing increasing financial pressures. S&P has a speculative B + rating on Evergrande.

National Chinese rating companies, meanwhile, rate Evergrande at triple A. At the end of September, China Chengxin Credit Rating Group said it was closely monitoring Evergrande news, adding that it was assessing whether it would affect the situation of overall credit of the company. At the end of the month, Evergrande avoided a short-term cash flow crisis after a group of strategic investors agreed not to force the company to cough up more than $ 12 billion as early as next January. Moody’s Corp.

holds a 30% stake in the parent company of the Chinese appraiser, China Chengxin International Corp.

Although Evergrande is not a state-backed conglomerate, the vast majority of triple A ratings in China have been awarded to state-owned companies and large corporations. Ailing airline-hotel conglomerate HNA Group Co., which has faced heavy debt over the past two years, is also ranked triple A in China.

A hangar of the HNA group at an airport in the Chinese province of Hainan in 2018.


Photo:

Matthew Miller / Reuters

“The methodology is different,” said Freddy Wong, Asia Pacific Manager for Invesco Fixed Income. Many companies with a triple A rating in China have either implicit or explicit government support, he notes, and most national ratings tend to fall into a narrow band compared to international rating scales. .

The official credit rating guidelines of the People’s Bank of China indicate that triple A ratings reflect an “extremely strong” ability to repay debt that is unaffected by an adverse economic environment and extremely low risk of default . The national scale ranges from triple-A to single-C and the lowest level is for issuers who are unable to repay their debts.

A seven-year study of the Chinese bond market and the credit rating industry found that more than 90% of national ratings were rated double A or higher in a sample of 6,528 bonds. National raters tend to lump bonds with very different default risks into one of the top three rating notches, he said.

Winnie Poon, a finance professor at Lingnan University in Hong Kong and co-author of the study, said more recently that national raters have also improved a significant number of corporate bonds of so-called vehicles from financing of local governments that have issued finance infrastructure projects.

According to Wind data, more than 140 of these off-balance sheet entities controlled by local governments have seen their ratings cut to triple-A since the start of the year. National rating companies have highlighted the stability of their local economies and the support of their government to justify the changes.

Some investors say it’s clear that not all triple-A rated bonds in China are created equal. Bonds with a higher risk of default in some cases generate two to three percentage points more than securities that investors deem more secure, Mr. Wong said of Invesco.

“Right now there is a lot of liquidity in the market which keeps defaults relatively low, but if the pandemic lasts for five years, that will be a different story,” he added.

Write to Serena Ng at serena.ng@wsj.com

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