China debt maturities reflect financial fragility

  • The Chinese government faces a challenge this year in tackling financial system risk against a backdrop of slowing economic growth.
  • The authorities are keen to press on with efforts to clean up the financial system.
  • Shorter maturities on debt issued by banks and corporations highlight growing unease among investors about the risks associated with this campaign.

Their confidence bolstered by a solid growth print, Chinese policymakers are pushing ahead with a financial system clean-up this year. They will need to tread carefully, though, as ever-shorter maturities on the debt sold by small banks and companies highlight funding strains that indicate progress will not move in a straight line.

More defaults are a given in 2018, although the government’s efforts to control this process will become more challenging. Evidence of a system-wide refusal to lend for longer reflects growing risk aversion among buyers of financial products — the banks, non-bank financial institutions and asset managers that are worried about being left high and dry during liquidity shortages. This means companies are reliant on shorter-term debt to roll over their liabilities, which makes them more vulnerable to the impact of tighter regulation and associated liquidity strains this year.

Despite regulation intended to crack down on irregular borrowing, the fragile state of funding conditions suggested by shorter debt maturities will require the authorities to take a pragmatic approach, providing liquidity where and when necessary to forestall systemic risk.

This fragility is evident among smaller banks, which borrowed heavily in the interbank market last year using negotiable certificates of deposit (NCDs). Issuance surged 55.6 per cent to Rmb20.2tn ($3.14tn) in 2017, but the weighted average maturity of these bond-like instruments dropped to 4.6 months, from about six months in 2016. The proportion of NCDs issued that mature within three months rose to an average 61.7 per cent last year, up from 45.1 per cent in 2016 (see chart).

The average maturity of corporate paper also shortened last year after the end of the domestic bond bull market. The weighted-average maturity of this debt — which includes corporate and enterprise bonds but also medium-term notes and shorter-term commercial paper — fell to 2.81 years last year, from four years in 2010 (see chart). Although issuance of corporate bonds has surged in recent years, helped by regulatory loosening, their weighted-average maturity fell to 4.52 years from 7.89 years in 2010.

Companies in sectors associated with overcapacity, such as steel and coal, have been largely able to roll over their maturing liabilities, but only by issuing shorter-term paper. The average term on paper sold by such companies did lengthen slightly last year as rising commodities prices helped improve their ability to repay debt. However, maturities have shortened considerably this decade relative to the rest of the corporate bond market.

The rise of short-term commercial papers, which carry maturities of less than one year, is another sign of corporate funding fragility. Such issuance increased to 44.1 per cent of the total outstanding, from 39.7 per cent in 2016 (see chart). Dandong Port Group and Dalian Machine Tools Group were high-profile defaulters last year. Both failed to make payments on their short-term commercial paper and we expect more defaults within this asset class in 2018 as rates continue to rise.

Companies are not only borrowing for shorter periods, they are also paying more to do so. The weighted average interest rate on corporate paper rose to 5.88 per cent in December, from 3.81 per cent in October 2016 when the bond bull market came to an end (see chart).

From a position of strength

The government has confirmed that 2017 economic growth exceeded its target. This position of strength helps explain the forceful tone with which regulators have begun 2018 and indicates that efforts to tackle financial system excess will increase.

The China Banking Regulatory Commission has started the year with an announcement of new guidelines to tackle what it calls “market chaos in the banking industry”. The People’s Bank of China is reportedly now controlling NCD issuance through a new quota system and will include these instruments in the quarterly assessments of the banking system. Insurance industry oversight is also set to tighten following the flame-out of several high-profile private insurers last year.

Although the banks are pushing back, the authorities also appear committed to introducing sweeping new rules by the middle of next year aimed at bringing order to asset management practices in China, including prohibitions on guarantees for investor funds.

These all point to a tougher credit environment this year, including further increases in market interest rates. Financial market defaults — once unthinkable — are occurring more frequently, although the flow remains a relative trickle despite the 200-basis-point increase in corporate yields since the peak of the bond market rally.

This reflects the authorities’ efforts to balance cleaning up the system with maintaining economic and financial system stability. They were generally successful in managing this process last year — although more was done to secure growth than to tackle risk — but shortening debt maturities against a backdrop of a slowing economy mean this will be a difficult trick to repeat in 2018.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.

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