Biggest Money Fund Shuns Companies on Default Risk: China Credit

Jan 28, 2014 11:10 pm ET

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Jan. 29 (Bloomberg) -- China’s biggest money-market fund has cut its holdings of corporate debt by more than 50 percent and sought safety in deposits as rising borrowing costs increase the threat of default.

“We won’t touch high-risk bonds that can have credit risks,” said Wang Dengfeng, Beijing-based manager at Tianhong Asset Management Co., which oversees the Yu’E Bao fund sold online by Internet billionaire Jack Ma. “Liquidity will remain relatively tight this year, as deleveraging continues to be the central bank’s focus. Authorities’ regulation of the interbank business and shadow banking may result in a period of pain.”

Yu’E Bao, whose 250 billion yuan ($41 billion) of assets make it the world’s 14th-largest money-market fund, cut corporate bills to 1.27 percent of holdings as of Dec. 31 from 3.18 percent on Sept. 30, according to its quarterly report. Bank deposits rose to 92 percent from 85 percent, and Wang said rates for such one-month interbank funds exceeded 6 percent this month. That’s higher than the average one-year AAA corporate yield of 5.86 percent.

People’s Bank of China Governor Zhou Xiaochuan has driven up borrowing costs to reduce appetite for debt, while regulators seek to avoid payment failures by trust funds and local- government financing vehicles. Investors staying away from corporate notes have led to an 18 percent slump in offerings in January from a year earlier, making it harder to refinance even as $427 billion of debt comes due in 2014.

Credit Events

China’s eleventh-hour rescue this week of wealthy investors in a high-yield trust, distributed by Industrial & Commercial Bank of China Ltd. to fund a family-run coal miner, shows the challenge faced by regulators trying to prevent excessive risk- taking. The Chinese Academy of Social Sciences estimates that the nation’s total debt accounts for 215 percent of gross domestic product.

Credit-default swaps insuring China’s debt against non- payment rose to 104.91 on Jan. 24, the highest since August, before falling to 92 yesterday on news that the potential trust default had been averted. ICBC told investors in the 3 billion- yuan product that they can sell their rights to recoup the principal. The product raised funds for Shanxi Zhenfu Energy Group, a coal miner which collapsed in 2012 after its leading shareholder was arrested for illegal deposit-taking.

Choosing Safety

Investors have been favoring safer bonds this year. The yield on the 10-year government bond has fallen five basis points to 4.51 percent, while the yield on similar-maturity AA corporate debt climbed 13 basis points to 7.77 percent. That widened the spread to 327 basis points yesterday, the most in almost two years. The similar AAA spread is at 180.

“It’s not very likely that government-guaranteed companies will default, but for small- and medium-sized enterprises, especially private companies or those in industries the government doesn’t support, we may see credit events,” Wang said in a phone interview yesterday. “These events will have a negative impact on the market in the short-term.”

The central government’s efforts to cut the economy’s dependence on exports and clean up the environment has hurt companies in industries such as coal and steel, increasing their borrowing costs and raising the chances of a default. The nation will ban new construction projects in the steel, aluminum and cement industries in the next few years to curb overcapacity, China National Radio reported on Dec. 23, citing Miao Wei, minister of industry and information technology.

Negative Outlook

Moody’s Investors Service said in its 2014 outlook it has a negative outlook on the coal and steel industry in Asia because of oversupply.

“The outlooks for key Chinese sectors such as property, oil and gas, utilities and retail are stable” as economic growth around 7.5 percent supports demand, Gary Lau, managing director for corporate finance at Moody’s, told a press briefing in Hong Kong last week. “However, companies in cyclical and oversupplied sectors such as mining and steel remain under pressure.”

Lending costs have also risen as the Communist Party’s third plenum in November decided to accelerate interest-rate liberalization. The central bank in June 2012 began allowing lenders to offer deposit rates capped at 110 percent of benchmark rates and removed the floor on lending costs last year.

Rates Jump

This contributed to a surge in money-market rates which will raise the risk borrowers won’t be able to meet commitments. The seven-day repurchase rate jumped to a record 10.77 percent on June 20 and averaged 4.09 percent last year, from 3.50 percent in 2012. The benchmark was 5.27 percent today, even as the PBOC pumped in cash to meet demand ahead of the Chinese New Year holidays starting Jan. 31.

“The central bank provided just enough money for commercial banks to get through the difficult time before the holiday,” said Yan Yan, a Shanghai-based analyst at China Guangfa Bank Co. “The PBOC’s relatively tight stance doesn’t seem to have changed.”

The rise in rates has been positive for China’s money- market funds, whose assets under management doubled to a record 737 billion yuan at the end of December from 304 billion yuan on June 30, according to Fitch Ratings.

While money-market funds rated by Fitch are conservatively managed, the composition of assets in other plans is “not very transparent” and qualified money managers are “very scarce,” Roger Schneider, senior director at Fitch’s Fund and Asset Manager Rating Group, said earlier this month. He estimates there are 90 so-called MMFs in China and only 10 have assets of more than 10 billion yuan.

Investment Options

“As China has just started interest-rate liberalization, the money market will continue to be attractive this year, with rates expected to remain at elevated levels,” said Tianhong Asset’s Wang.

His fund, sold online by Alibaba Group Holding Ltd. affiliate Alipay.com, is open only to individual investors. Assets grew 35 percent in the first 15 days of this month, while the number of clients rose 14 percent to 49 million as of Jan. 15, according to the company.

Money-market funds’ assets under management could exceed 2 trillion yuan by the end of this year, and climb to 5 trillion yuan, or about 10 percent of the nation’s economy, by 2020, according to a Jan. 2 report by Credit Suisse Group AG.

Yu’E Bao offers an annualized return of 6.7 percent, compared to the 3 percent one-year deposit rate. Other money- market funds are offering even higher returns, with news portal Eastmoney.com, for example, marketing a product that targets 10 percent.

“These funds offer returns close to that of wealth- management products and trusts, but they are more regulated and have better liquidity,” said Wang Bo, head of marketing at Fortune SG Fund Management Co. in Shanghai, a joint venture between Baosteel Group Corp. and Societe Generale SA. “The success of Yu’E Bao lies in the fact that it brought the money- market fund in front of the right people at the right time.”

--Helen Sun. Editors: Robin Ganguly, Sandy Hendry