One month ago, when looking at the surprising spike in Chinese corporate bond defaults - which yesterday added one more company to the list after Wintime Energy missed a 1.6bn yuan bond repayment in principal and interest - we asked if "it is time to start worrying about China's debt default avalanche."
Fast forward one month to today when Goldman's credit analyst team headed by Kenneth Ho, said that "the past week we met with investors in Guangzhou and Shenzhen, and the tone remains very negative" for one reason: most investors suddenly feel as if they have lost the backstop of the central bank, which until recently would never allow corporate bankruptcies, and suddenly - as part of the country's deleveraging campaign - is eager to take air out of the system, while at the same tine draining liquidity out of the system. Or, as Goldman writes, investors "would like to see policymakers provide more targeted lending to help with refinancing needs, and view that the recent liquidity injections are too broad to be able to alleviate the market concerns."
Here are some more details from Goldman's Kenneth Who, who writes that "Over the past week, we met with a number of investors in Guangzhou and Shenzhen. Most were equity investors, together with a number of macro and credit asset managers."
A simply visual summary of these concerns is shown in the chart below, according to which Chinese financial conditions are now roughly tied for the tightest ever since the financial crisis, mainly due to slower credit growth and stronger currency in May.
The following are the key takeaways from Goldman's meetings:
Investors continue to have a long list of worries. Similar to the feedback from our recent trip to Beijing, most investors are worried about the trade war, defaults, and credit crunch, with particular concerns about liquidity in the LGFV and property sectors. After the sizeable RMB depreciation in recent days, we noted increased worries about policymakers' stance towards the RMB, and concern that further RMB depreciation would trigger capital outflows. Overall, investor sentiment remains very cautious, and are meaningfully more bearish than offshore investors.
Goldman notes that investor focus is on, what else, potential policy support: after all it is so much easier to buy when you know the central bank has your back. According to the Goldman analysts, most investors are looking to policy action that could help turnaround investor sentiment, and question what types of measures policymakers could adopt.
Below are the three key measures Goldman discussed with investors:
- Measure #1: Targeted lending. PBOC's expansion to include AA-rated corporate bonds as collateral for the Medium-term Lending Facility (MLF) and the recent 50bps cut in RRR were taken as efforts to provide broad liquidity in the financial sector. To us, these measures indicate policymakers' awareness of the credit issues. However, many questioned whether these policies by themselves would be sufficient, as they are considered to be too broad-based. Investors would like to see more targeted measures that help to direct credit flows to the smaller companies that are reliant on shadow bank for funding.
- Measure #2: Fiscal support. A number of investors were also wondering which fiscal tools could be used to provide support for growth. Many took it as a negative shock that China Development Bank suspended new Pledged Supplementary Lending (PSL) to fund shantytown upgrades, as reported by Caijing. On-budget fiscal stimulus will also likely be less supportive in the second half, as our China economists estimated that on-budget spending earlier this year was the most front-loaded compared with the past few years. Overall, we expect some fiscal headwinds in the coming months, but should there be significant slowdown in growth, policymakers will likely provide support, such as bringing back PPP projects as reported by Xinhua.
- Measure #3: Financial reform easing and forbearance remain as options. There was a general consensus amongst investors that more defaults will come in the second half of this year, and that financial tightening will unlikely ease in the near term. While we share a similar view, we continue to believe that policymakers will oscillate between reform and forbearance. In our view, there will likely be a more supportive forbearance stance if growth slows and credit concerns become a major worry.
Still, despite the growing default worries, fears of a credit crunch and rising yields, the Chinese bonds market remains stable and gross issuance is at a faster pace even compared with 2017.
For the first six months of this year, total gross corporate bond issuance in China's domestic bond market reached RMB 3.4tn, representing an increase of 44% compared with 1H17. To us, this indicates that the onshore bond market is still functioning, despite fear of a credit crunch. Though it is worth noting that only 12% of the gross issuance this year has come from AA-rated companies, compared with 20% in 1H17, suggesting that liquidity is abundant for better credits, but less so for weaker ones (Exhibit 1).
That said, risks of sharp changes are lurking, and as Goldman writes, while the bank believes that the overall corporate bond market is still functioning, it sees potential increase in tail risk. To wit:
Bond market redemptions have been heavy in recent quarters, and will remain heavy in the coming quarters (Exhibit 4), and the areas we see having the biggest risks are the weaker credits. It is clear that the markets are increasingly pricing in concerns for the lowest-rated credits (Exhibit 5). As such, we continue to hold the view that it is too early to bottom fish on the highest yielding Chinese credits.