Why S&P’s China credit rating action has a limited impact for Chinese bonds

Postal Savings Bank of China’s AT1 bond issuance still performed well, despite downgrade

People's Bank of China, Beijing
People's Bank of China, Beijing

WHEN S&P lowered China’s credit rating on September 22 for the first time in 18 years, the market didn’t react with panic. Instead of a sudden credit spread hike, the credit spread of China USD bonds dropped by 3.3bp on the same day, demonstrating strong confidence from bond investors.

While a lower credit rating is commonly equivalent to a higher financing cost for the issuer, it is expected that the downgrade action, which China’s Ministry of Finance described as the “wrong decision”, will have a limited impact on investor appetite for China assets, much of which is purchased by Chinese investors. According to ANZ, Chinese investors took up about 65% of the debt sold by Chinese issuers in the first half of 2017.

“Even though China has been downgraded, from an investor’s perspective, the size of Chinese bond market can still attract a lot of investors,” says Freeman Tsang, head of China and Hong Kong at Legg Mason. “Whether the downgrade action will affect the long-term investment demand depends on the yield and the overall market sentiment,” Tsang adds.

The downgrade also merely brings S&Ps credit rating in line with the ratings of Moody’s and Fitch, making the move more of a normalization. Further, all three ratings agencies have China on a ‘stable’ outlook, as opposed to negative, indicating no further credit ratings actions on the horizon.

On September 22, the Postal Savings Bank of China’s (PSBC) AT1 bond issuance still performed well, despite the downgrade. The deal was priced at the tight end of the final price guidance and was initially quoted at 99.25 in the early morning, but recovered to 99.60-99.70 in early afternoon. The quick price recovery showed a solid demand in the bond from the state-owned bank.

China is also bolstered by a new generation of high net worth individuals who are familiar with China as a home market, and will continue to invest in China credit. In Asia more broadly, Chinese high net worth individuals (HNWI) form a large part of the client base. As of 2016, there were 1.58 million people with total wealth over 10 billion yuan, according to a report from China Merchants Bank and Bain & Company.

“From a private banking perspective, a lot of high net worth clients are from mainland China or they have business with China,” says Ronald Liu, vice president at Legg Mason. “They are quite familiar with China and they do not only read newspaper to learn about China. They look at China as a place to put a long-term investment.”

There will also likely be increased interest from foreign investors in the China onshore market as it continues to open up to foreign capital. Currently, foreign investors only account for 2% of bond holdings, however, new initiatives such as the Bond Connect will likely bring more overseas investors to China’s interbank bond market in a longer term.

“When bond connect was launched, it does not seem too attractive because it takes time for each company to further assess the Bond Connect,” says Tsang. “But in the future, we believe that the onshore bond market will become more attractive.”