After two years of stratospheric growth in bank lending, China’s economic planners are following through on promises to pursue tighter monetary policy. In December, Beijing announced that it would move to a “prudent” policy, away from a “moderately loose” one. As a key part of this move, new bank lending, which had totaled US$1.4 trillion in 2009 and US$1.2 trillion in 2010, would be curtailed.
The new lending figures from January suggest that the approach has had some success. While banks tend to front-load their new loans toward the beginning of each year, lenders gave out just US$158 billion in new loans in the first month of 2011, down from about US$211 billion last year, and well below market expectations.
Not coincidentally, the new year also brought with it news of widespread bond issuances by Chinese corporations seeking an alternative source of funds: In the first three weeks of the year, they raised a record US$15.2 billion in bond sales on the domestic market, and they didn’t stop there: China Petroleum and Chemical Corp (SNP.NYSE, 600028.SH, 0386.HK) was set to sell US$3.5 billion worth of convertible corporate bonds in mid-February in the largest convertible bond issuance in the Asia-Pacific region since August 2010.
With bank lending newly restricted, and with equity markets continuing to underperform, bond issuances have emerged as a favorite financing tool for cash-hungry Chinese firms.
Skewed development
On the surface, the rise of bonds may be a welcome development for the government as companies are weaned from dependence on bank loans. “There is a trend for the bonds to replace bank loans in the long term,” said Wang Yang, director of fixed income research at UBS Securities (UBS.NYSE) in Beijing. However, the bond issuance in January may not exactly reflect the kind of development that central authorities seek.
In particular, the surge in debt since the beginning of the year – much of it renminbi debt issued in Hong Kong – has not just stood in the way of Beijing’s attempts to control liquidity, but has raised concerns about overextended companies. Ratings agency Standard & Poor’s said in mid-February that rapid debt issuance had weakened the credit profiles of many Chinese real estate developers.
“An increase in leverage has more than offset any improvement in debt maturity profiles and liquidity,” the agency noted in a report, drawing attention to Glorious Property (0845.HK), Kaisa Group (1368.HK) and Renhe Commercial (1387.HK), three developers it recently downgraded. It also warned that debt issuances posed a threat to the credit ratios of Evergrande Real Estate (3333.HK) and Country Garden (2007.HK).
Not all of these companies turned to debt issuance out of desperation for financing. “To be honest, we don’t have difficulties securing financing from domestic banks,” said Jimmy Fong, a spokesman for Evergrande, which raised US$1.4 billion in renminbi-denominated debt in Hong Kong. He noted that the company maintains US$3 billion in cash on hand, and has access to other financing vehicles.
Fong explained that issuing renminbi-denominated debt in Hong Kong was a simple financial decision: The bonds represent a cheaper and more flexible form of financing than alternatives such as construction bonds and increasingly expensive bank loans, and they effectively protect the company from policy-related risks.
“Because of unexpected government policies, and … uncertainties in terms of the atmosphere in not getting funding, three- to five-year year maturity bonds will put us in a very favorable position against any unexpected turbulence,” Fong said.
At the same time, he dismisses concerns about possible downgrades of Evergrande’s debt, noting the company’s strong sales growth in January and a focus on high-growth, lower-tier markets.
The advantages of renminbi-denominated bonds listed in Hong Kong – known as “dim sum” bonds when traded in renminbi, and as “synthetic” bonds when traded in US dollars to take advantage of a much larger pool of liquidity – have appealed to more than just domestic developers. Last November, the Ministry of Finance undertook its second bond issue in Hong Kong, selling US$1.21 billion in renminbi-denominated debt. That issue came shortly after McDonald’s (MCD.NYSE) became the first foreign non-financial firm to sell renminbi-denominated bonds in Hong Kong, with
a US$29 million issue in August.
The Hong Kong bond issues have proven popular among investors seeking to take advantage of an appreciating renminbi while avoiding restrictions – namely capital controls – that prevent them from investing directly in the mainland debt market. Wang at UBS said he expects the Hong Kong market to develop rapidly as interest grows among investors, foreign-incorporated Chinese firms like Evergrande, and large overseas players. The focus of most Chinese firms seeking to raise capital, however, will remain domestic.
“In a couple of years, we will see more issuers in offshore markets [like Hong Kong], but I don’t think it will be comparable to the local bond market,” he said.
That is not to say the domestic bond market is without its own problems. It remains stymied by regulatory overlap, with different corporate debt instruments overseen by the China Securities Regulatory Commission, the National Development and Reform Commission and the People’s Bank of China (PBoC).
Rapid growth in domestic bond issuance is a clear sign of demand for these financing instruments, but it comes despite, not because of, the regulatory environment. That may change as Beijing continues to encourage the use of bonds in place of bank loans, but it’s a mistake to assume that the market will be allowed to develop too freely.
As they attempt to tighten the policy environment, regulators will be little more willing to tolerate huge growth in debt issuance than in bank loans. The PBoC’s introduction of a new liquidity measure that includes credit sources such as corporate bonds is a sign that authorities are keeping a close eye on the development of debt markets.
“Both bank loans and the bond market are supervised by regulators and the central government,” said Wang. “If [Beijing] wants to keep bank loans growing at a slower pace, I don’t think the bond market can provide any leeway for companies to raise a lot of money.”