Tuesday, 1 December 2020

 

Ratland China rating agencies stand by SOEs despite default spree

A neighbourhood near a coal-fired power plant in Shanxi, China, in November 2015
Yongcheng Coal and Electricity Holding Group, one of China’s largest coal groups, kicked off a spate of defaults last month © AP

China’s credit rating agencies are standing by their triple A scores for troubled state-owned enterprises, even as a series of defaults reverberates through the country’s $4tn corporate debt market.

Just five Chinese companies out of more than 5,000 have been downgraded to below double A ratings by domestic rating agencies since Yongcheng Coal and Electricity Holding Group, one of the country’s largest coal groups, kicked off a spate of defaults last month, according to data provider Wind.

Double A ratings are crucial in China as groups with lower ratings cannot issue publicly traded debt. More than 98 per cent of the outstanding bond issuance in the country is backed by issuers graded double A or higher. Since it defaulted, Yongcheng has become one of the few companies to be relegated below this mark.

China’s rating agencies are even worse than [those] in the US

Andrew Collier, managing director of Orient Capital Research

Analysts said the reluctance to downgrade companies reflects the influence of politics in China’s credit markets. For the market’s dominant state-owned enterprises, a rating of double A or higher is often based more on the assumption that authorities will always bail out government-linked companies rather than on their business fundamentals. Some investors said they do not rely on local ratings.

“China’s rating agencies are even worse than [those] in the US,” said Andrew Collier, managing director of Orient Capital Research in Hong Kong. “They’re not only beholden to the customer but also [to] the government.”

Rating agencies such as China Chengxin or CSCI Pengyuan apply a letter-based scale that resembles those of international peers such as S&P Global or Fitch Ratings.

But fierce competition among Chinese agencies, most of which are state-controlled or have government ties, leaves them with little incentive to rate clients lower than double A or risk losing business.

Before November, just five Chinese SOEs had defaulted in 2020, according to Fitch. That number has since jumped to eight.

“The lack of downgraded ratings is only one of the privileges enjoyed by SOEs,” said Bruce Pang, head of macro and strategy research at investment bank China Renaissance, who points out that state-linked groups also generally enjoy vastly better access to capital markets than their private counterparts.

Line chart of Average yield on one-year medium-term notes (%) showing China bond yields spike after onshore defaults

Investors have begun viewing triple A rated debt in China as riskier, even if rating agencies have not. The average yield on bonds rated double A or higher has jumped about 0.4 percentage points since Yongcheng defaulted on November 10. Yields on triple A rated debt recently rose to the highest level in a year.

“It’s going to have an impact,” said Jenny Zeng, co-head of Asia-Pacific fixed income at AllianceBernstein, of the recent defaults and higher yields. She added that while onshore ratings were not “completely useless . . . from a credit perspective, I would rather just do my own work”.

Analysts expect more defaults of government-linked entities in China, with Beijing more willing to let some groups fail partly to encourage investors to better price risks associated with these companies.

Hayden Briscoe, head of Asia-Pacific fixed income at UBS, said this would still be unlikely to prompt a spree of material downgrades by China’s rating agencies.

But from now on, he said, investors would probably apply far more attention to the “minuses, plusses and flats” within the double A to triple A plus range.

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