In August, the IMF warned on China’s “dangerous” debt that could lead to a new global financial crisis. Asset managers have also issued their own risk alerts.
Under pressure to control the over-levered domestic credit situation, Chinese authorities have been pushing corporates to reduce debt, resulting in a number of corporate bond defaults. To date, China has had 17 onshore bond defaults, according to data from Bloomberg. However, the number seems to be on track to match last year, when 29 defaults occurred,
This month, Wuyang Construction Group, a builder in the eastern province of Zhejiang, defaulted on two put-able notes totaling RMB 1.36bn ($209m).
But Salem said that the bank is monitoring China credit risk and he believes the Wuyang default will not have widespread consequences.
“China is proactively dealing with overcapacity and deleveraging, which also brought tighter financial regulations in recent years,” said Salem. “In this process, some weaker corporates are being squeezed out in a way to address the moral hazard issue and to promote risk premium discovery and rebalancing.
“The process is being managed cautiously, which is why we did not see much impact on offshore bond valuations,” he added.
In fact, dim sum bonds (issued offshore but RMB-denominated) have outperformed the global corporate bond market year-to-date. The Citi Dim Sum Bond index is up 9.71% year-to-date in US dollar terms (in RMB terms up about 4%).
Additionally, dim sum bonds have one of the higher yields in the bond spectrum if high yield products are excluded. According to the bank’s latest monthly report, dim sum bonds were yielding around 4%.
Offshore bonds
Over the past 12 months, Citi had been advising private bank clients to gradually take profit on offshore Chinese credit due to tight spreads. During the period, the China exposure in newly-setup bond portfolios for clients in Asia fell to 35% from 50%.
“We could find more attractive bonds elsewhere, such as European utilities and banks, US commodities, Latin American banks, energy and infrastructure, Japanese insurers, as well as Asean banks,” said Salem.
However, Citi PB is no longer seeking to reduce exposure. Salem said selective opportunities have emerged against the backdrop of China’s improving macroeconomic outlook, which will benefit some issuers such as those in the property and financial sectors.
Moreover, the RMB is up 5.6% this year versus the US dollar, according to FE data. With a stronger RMB, there is also scope to increase exposure to dim sum bonds to take advantage of positive carry and potential long term currency appreciation, Salem said.
So far in 2017, dim sum bonds have outpaced global high yield and global corporate in US dollar terms. Performance in RMB terms is about 4%.
