By Serena Ng
China's credit-rating firms are doling out more triple-A bond ratings, a trend that has continued this year in spite of the coronavirus pandemic and greater borrowing by companies in the world's second-largest economy.
As of mid-October, more than 18.3 trillion yuan, equivalent to $2.7 trillion, in outstanding yuan-denominated bonds issued by companies and financial institutions in mainland China had the highest possible rating from the country's credit raters, according to data provider Wind and asset manager Invesco Ltd.
Bonds with triple-A grades currently make up 57% of all the onshore Chinese corporate debt that is outstanding. The proportion of top-rated debt has climbed in recent years. In 2015, about 37.5% of corporate debt in mainland China was rated triple-A.
In the U.S. and many other countries, triple-A corporate bond ratings are rare and have been awarded to the financially strongest debt issuers with minimal default risk. Microsoft Corp. and Johnson & Johnson are the only American corporations with the coveted grade from S&P Global Ratings. In the U.S. dollar bond market, S&P has rated about 300 nonfinancial Chinese companies, giving them grades of single-A-plus to triple-C-minus.
In China's vast domestic debt market, triple-A ratings--mostly awarded by domestic raters--are commonplace. S&P and Fitch have Chinese subsidiaries that rate a small number of Chinese institutions and they have similarly been awarded triple-A grades. Their subsidiaries' rating scales and methodologies in mainland China differ from what the firms' use internationally.
China's unique bond-rating system poses challenges for international investors who are looking to enter the market or hold global index funds that own domestic Chinese bonds, said Kate Jaquet, a co-portfolio manager at Seafarer Capital Partners, a Larkspur, Calif.-headquartered investment firm.
"A rating scale like that is not healthy for a bond market," she said.
Foreign investors have been increasing their holdings of yuan-denominated bonds, though their participation in China's $14.5 trillion domestic bond market is still small and they have, for the most part, stuck to government debt and bonds from state-owned development banks.
The pattern of issuing more triple-A ratings in China has been a bit of a head scratcher for international investors and analysts. Companies have been borrowing more during the pandemic and some have put off repaying banks and investors after their revenues took a hit. China's economy, however, has recovered faster than much of the world; the country said this week that third-quarter GDP grew 4.9% from a year earlier.
While bond defaults in China happen less frequently than they do in the U.S., they have been ticking higher this year. Some companies have blamed lockdowns, business closures and a slowdown in economic activity caused by the spread of the coronavirus. Defaulters have included real-estate developers, manufacturers and highly indebted conglomerates.
"The trend of rising ratings is clearly contrary to the overall trend in credit risk within China's corporate bond market," said Logan Wright, director of China markets research at consulting firm Rhodium Group. Elsewhere in the world, there have been numerous corporate bond-rating downgrades as economic slowdowns have reduced revenues for many firms.
Owen Gallimore, head of credit strategy and research at ANZ, said China's onshore debt markets appear to have benefited from injections of large amounts of liquidity from the country's central bank during the pandemic. Broadly speaking, Mr. Gallimore said he feels domestic ratings in China aren't good measures of credit risk. A triple-A grade "tells you whether the company is important or not," he added, and there is an expectation that the government won't let state-owned enterprises and large politically connected firms fail.
Consider the case of China Evergrande Group, the country's most indebted property developer and the largest junk bond issuer in Asia's dollar bond market. Last month, prices of Evergrande's shares and bonds plunged in value after documents circulated online said the company was in a tight financial spot, with a deadline looming to take a key subsidiary public or repay certain investors billions of dollars.
On Sept. 24, S&P changed its outlook on Evergrande to negative, saying it believed the group's liquidity was weakening and it was facing increasing financial pressures. S&P has a B+ speculative-grade rating on Evergrande.
Domestic Chinese rating firms, on the other hand, rate Evergrande at triple-A. In late September, China Chengxin Credit Rating Group said it was closely monitoring news from Evergrande, adding that it is evaluating whether it will affect the company's overall credit situation. At the end of the month, Evergrande staved off a near-term cash crunch after a group of strategic investors agreed not to force the company to cough up more than $12 billion as soon as next January. Moody's Corp. has a 30% stake in the Chinese rater's parent, China Chengxin International Corp.
While Evergrande isn't a state-backed conglomerate, the vast majority of triple-A ratings in China have been awarded to state-owned enterprises and large companies. Troubled airlines-to-hotels conglomerate HNA Group Co., which has struggled with heavy debts over the past two years, is also rated triple-A in China.
"The methodology is different," said Freddy Wong, head of Asia-Pacific for Invesco Fixed Income. Many companies with triple-A ratings in China have implicit or explicit government support, he notes, and most domestic ratings tend to fall into a narrow band when compared with international rating scales.
Official guidelines on credit ratings from the People's Bank of China say triple-A grades reflect an "extremely strong" ability to repay debt that is unaffected by an adverse economic environment, and extremely low default risk. The domestic scale goes from triple-A down to single-C and the lowest rung is for issuers who are unable to repay their debts.
A seven-year study of the Chinese bond market and credit-rating industry found that more than 90% of domestic ratings were rated double-A or higher in a sample of 6,528 bonds. Domestic raters tend to pool bonds with very different default risks into one of the top three rating notches, it said.
Winnie Poon, a professor of finance at Lingnan University in Hong Kong and a co-author of the study, said more recently, domestic raters have also upgraded a significant number of corporate bonds from so-called local government financing vehicles that have issued debt to fund infrastructure projects.
More than 140 of these off-balance-sheet entities controlled by local governments saw their ratings upgraded to triple-A in the year to date, according to Wind data. Domestic rating firms pointed to stability in their local economies and support from their government in justifying the changes.
Some investors say it is clear not all bonds rated triple-A in China are equal. Bonds with higher default risk in some cases are yielding two to three percentage points higher than securities that investors perceive to be safer, said Mr. Wong of Invesco.
"Right now there's a lot of liquidity in the market, which is keeping defaults relatively low, but if the pandemic lasts for five years, it's going to be a different story," he added.
Zhou Wei contributed to this article.
Write to Serena Ng at serena.ng@wsj.com
(END) Dow Jones Newswires
10-21-20 0544ET
