State-owned enterprises are not as homogeneous in China as they are in other parts of Asia, so investors should be extra careful when buying their bonds, Fidelity Worldwide Investment said in a media press briefing today.
Only around 17% of Chinese SOEs receive strong day-to-day government support, with 28% getting medium-to-strong day-to-day support and the remainder low but some levels of support, Fidelity said, citing a recent study of the sector.
Levels of extraordinary support – including that of a potential government bailout in the event of default – also vary significantly and are difficult to gauge due to a lack of historical evidence, said Sabita Prakash, head of Asian fixed-income at Fidelity Worldwide Investment at the briefing in Hong Kong.
“There is no way that constitutes to someone receiving extraordinary support when it is not even being seen yet,” she said. “The government can continue to support the entities by allowing the bonds to default and then restructuring the bonds. This ensures that the company continues to operate.”
In contrast, SOEs in South Korea have either huge amounts of support or are quite independent, Fidelity said.
“In many of the Korean quasi-sovereign cases, there is a law that specified that the government will always own those companies or banks,” said Prakash.
Due to the added uncertainties in China, bonds issued by Chinese SOEs tend to come with keepwell agreements, which are contracts between a parent company and its subsidiary to maintain solvency and financial backing throughout the term set in the agreement.
However, these so-called credit enhancers are vague in nature compared with the letters of credit (LC) that are widely used as guarantees by South Korean and Indian SOEs, highlights Fidelity.
“The keepwell agreement is like a moral obligation on the part of the parent to support to subsidiary, but whether the support will come on time and whether the authorities will allow that kind of support is yet to be seen,” said Prakash. “The reason for the usage of a keepwell agreement is to circumvent the regulation for guarantees.”
“LCs are more dependable in terms of transferring the credit risk of that individual entity that is being supported up to the supporting bank,” she added.
As a result, Fidelity said investors should do their own due diligence and create a scorecard to assess government support rather than just rely on credit ratings, which in any case had diverged hugely in recent years leading to a jump crossover credits – SOEs with ratings that were both investment grade and high yield, depending on credit agency.
Fidelity also highlighted a case study where the parent company has a standalone rating of Ba2/BB/BBB- but an overall rating of Baa1/BBB/BBB+.
“There is a significant difference in standalone versus overall ratings of a Chinese SOE,” said Prakash. “While we do argue that there is a place for government support to be factored into ratings, at the end of the day, when market conditions are so unpredictable, you’d rather be in a space where you are at least comfortable with the entity’s standalone ratings.”
Fidelity said its findings were based on a study of government support for approximately 40 Chinese SOEs from a variety of industries.
