Bond issuance in July accounted for 24% of all financing needs in China’s onshore market – an all-time high for the securities which have always lagged bank lending, the traditional go-to mode of financing for state-backed and independent corporate borrowers alike.
This marks a turn of tide for the bond market - which regulators have pushed to become a more prominent financing channel to ease systemic risk to the banking system – and is something that will only continue amid more volatile bank lending patterns, say China analysts.
According to the People’s Bank of China (PBoC), new lending in the country slowed to a 10-month low in July, to Rmb540.1 billion (US$84.9 billion) from Rmb919.8 billion in June, representing a more than 41% plunge. However, new loans for the month increased 16% year-on-year.
While a summertime decline in lending is nothing new, what took market participants by surprise was the severity of the drop, taking loans’ share of social financing – the measure of funds raised by entities in the real economy - from 69% in May to 52%.
“In July, bank lending declined by a large amount. It’s not surprising to see a decline, because that happens each year, but it was still a huge amount and it affects the market,” said Dariusz Kowalczyk, a senior economist and strategist at Crédit Agricole, adding that lending levels were up year-on-year by approximately 45% in May and June before seeing the decline in July.
“But while that number looks drastic, social financing on the whole didn’t look so bad because there has been a huge increase in bond issuance this year, with 24% of all funding coming through bonds in July – that’s the highest ever and offsets a drop in lending to an extent,” he added.
More than US$197.1 billion of bonds were issued in China from January-July 2012, up from US$117.6 billion during the same period in 2011, according to data provider Dealogic. This represents a 67.6% increase.
PBoC data further shows that throughout 2012, bonds’ share of the social financing market ranged from a low of 5% in January to a high of 15% in February before the new peak reached in July. From March through June, bonds represented an average 11% market share of social financing onshore. In July 2011, bonds represented 8% share of social financing.
According to China analysts, bonds’ share of financing in July was irregularly high due to the drop in new lending, and a ratio of 24% will be unsustainable for the remainder of 2012. However, the concept that bonds are becoming a more prominent mode of financing – even over loans – is real.
“Bonds will definitely account for a much larger share than before,” said Bin Gao, a rates strategist at Bank of America-Merrill Lynch. “The 24% we saw in July is probably a little too high and we won’t necessarily see that level throughout this year, but we expect that bonds will become more central to companies’ regular financing and volume will increase in the future and bonds’ share may grow compared to lending.”
He notes that the boost of bonds’ prominence largely stems from regulators’ ongoing efforts to strengthen and develop the market.
“What we’re seeing is very consistent with what regulators have been discussing and planning with regards to opening the capital market to provide more funding to corporates,” said Gao. “It’s been a long-standing goal to draw systemic risk in away from the banking system because there’s been too much reliance on loans. And as the economy develops the ongoing question of where companies can find funding will become more central.”
Zhi Ming Zhang, head of China research at HSBC, adds that many Chinese borrowers have moved past the phase where short-term bank lending – which is typically less than one year in China – will suffice to finance their longer-term infrastructure and operational requirements.
“Banks are capital constrained and are reluctant to lend, especially to privately owned entities that need financing,” he said.
Analysts add that regulators from the National Development and Reform Commission (NDRC), National Association of Financial Market Institutional Investors (NAFMII), China Securities Regulatory Commission (CSRC), Chinese Insurance Regulatory Commission (CIRC) and the PBoC have worked together to promote credit issuance in their own ways. This includes the launch of China’s first high yield bond market, which is regulated by the CSRC; allowing insurance companies to invest greater amounts in bonds, which is overseen by CIRC; and allowing local municipalities to issue debt directly, which was a NAFMII plan.
“China has been pushing for the development of the market and regulators have been doing a lot of things to promote the market,” said Kowalczyk. “It hasn’t been one major breakthrough that they’ve done to help the market, but a lot of things have begun to add up.”
However, bonds aren’t expected to overtake bank lending – rather, China’s overall lending pool is expected to expand. While this will benefit participants in both the loan and bond markets, volume in the bond market in particular is expected to increase steadily due to support from regulators and ongoing volatility related to the direction of the loan market.
“At least for this year and next we’ll see that bond issuance will continue to grow, and it will be the main growth engine to supply credit to domestic borrowers,” concludes Zhang. “Loans will continue to grow because a lot of large projects are still being approved and the government will still support economic growth, and so they’ll come back stronger than July figures but at a slower growth pace than bonds. But banks will be hesitant to take on longer-term loans, so borrowers may turn to places where they can find long-term funding, which is the bond market.”