March 24, 2017

Get while the gettin’s good

by Breakingviews

Chinese dollar-bond issuers are having a moment in the sun. A recent regulatory tweak allowing businesses to make onshore guarantees to offshore buyers has attracted yield-hungry foreign investors. But as liquidity tightens and interest rates rise, expect more defaults. And those guarantees could prove unreliable if things go wrong.

Chinese firms have sold $30 billion of dollar bonds abroad this year, according to Thomson Reuters data, up more than threefold on the same period last year. And international investors seem especially blasé about credit risk: Morgan Stanley analysis suggests offshore markets make less of a distinction between riskier and comparatively safe credits than onshore markets.

That has been good for high-yield issuers like Fosun International. The conglomerate’s $800 million bond on March 17 was the first by a Chinese dollar issuer in Asia since the U.S. Federal Reserve hiked rates. It went well. Oversubscribed by more than four times, the 5-year issue was sold at face value to yield 5.25 percent. Fosun says the coupon is the lowest it has ever paid on a bond.

In the past many borrowers had to rely on “keepwell” deeds when issuing dollar bonds. These are not iron-clad guarantees of payment, but rather promises to keep the overseas entity solvent. They provide scant legal recourse for investors. There are about $20 billion such bonds outstanding.

But Beijing, worried about the yuan sliding further against the dollar, wants to bring dollars home to keep its $3 trillion hard-currency reserve stocked. In January it allowed firms to offer overseas investors guarantees from the onshore entity that controls all the mainland assets, an improvement over keepwells.

How much these paper guarantees are worth will need to be tested in Chinese court. That test may come sooner than later. Domestic rating agencies think regulators will permit more defaults this year, as they reel in excess credit. The central bank is cautiously tightening liquidity and hiking short-term rates. That will inhibit refinancing, and some debt-sodden companies can’t do without it.

If the economic recovery underway in the first quarter takes hold, a rising tide may lift all boats. But if storm clouds gather, foreign bondholders may find themselves exposed to more risk than they bargained for.

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