China investors see more risk in high-yield bonds

 Reuters

Hong Kong/Shanghai

The additional spread that investors demand for credit risk in China is at the highest level in nearly 15 months as investors in the country’s corporate bond market start pricing in the impact of an ongoing crackdown on low-grade issuers.

The spread between the one-year yield on AAA-rated bonds and those rated AA has widened to 112.4 basis points, a level not seen since September 2013 and wider than the period shortly after China saw its first public bond default by Chaori Solar in March.

“It’s the lagging effect from the new regulations to exclude higher-yield bonds of AA and below from repo business,” said a senior dealer at an Asian bank in Shanghai, referring to a policy announcement preventing weaker issuers from using the bond market as a refinancing tool.

“That means investors are now more aware of the risk of high-yield bonds because of policy guidance.”

Corporate bonds are still relatively lightly traded in China, with most still bought and held by banks.

Building a healthy bond market as an alternative source of fundraising for corporates is a key goal for Beijing, but while rhetoric has been firm, progress has been hobbled by the inability of Chinese bureaucrats to tolerate defaults.

For example, the last time the spread widened was in March, during the default of Chaori Solar, a little known Chinese firm that failed to pay interest on a bond by its due date.

That was hailed as a major step forward for risk pricing reform in China, but although the bond was minor and the company economically insignificant, nevertheless officials managed to engineer a total bailout of bondholders - paying them both interest and principal – later in the year.

But changes in yield do reflect wider market assessment of Beijing’s commitment to financial reform and have fluctuated in response to policy.

The change follows signs of increasing financial stress in China, with non-performing loans on the rise at Chinese banks, sliding deposits at banks and deflationary pressure.

A survey published last week by the Chinese central bank showed the number of Chinese bankers who believe the country’s economy is cooling increased in the fourth quarter from the third, and a “confidence index” of bankers dropped.

The China Banking Regulatory Commission (CBRC) has also asked lenders to step up efforts to rein in lending risks in 2015.

Meanwhile Chinese investment banks have awarded pay rises to their staff for the first time since the 2008 global financial crisis, buoyed by a surge in China-related deals, but salaries and bonuses still trail far behind those paid by Western banks.

Chinese investment banks traditionally baulk at paying outsized salaries, though some are just as profitable as Wall Street rivals. They were especially frugal in the lean years after the crisis, but this year’s boom has finally loosened their purse strings, headhunters and compensation experts say.

“This is the first time since 2009 we have seen an increase of base and total compensation,” said Maggy Fang, managing director for executive compensation in Asia Pacific at human resources consultancy Towers Watson. Chinese investment banks raised bonus payouts by an average of around 12% this year, while base salaries for the sector rose by about 6.5%, according to Towers Watson. Overall, total compensation levels at Chinese investment banks rose 9.2% in 2014.

Bonuses are expected to rise again in 2015, said Fang, though she did not give a figure.

Pay levels at China’s investment banks have a long way to go to catch up to those at international firms. Chinese banks pay around half as much as their Wall Street rivals in terms of base salary, say headhunters.