That knocking coming from a small corner of the Chinese debt market is the sound of private business owners banging on doors for bond financing.
The noise has been drawing considerable attention since 2011, when bond issuance by China’s small- and medium-sized enterprises (SMEs) — most of which have an annual revenue of less than 300 million yuan ($48 million) and have little access to bank credit — nearly tripled from the year before. And it’s sweet to the ears of Chinese officials, who have been encouraging support for SMEs since 2009 when the State Council, China’s cabinet, introduced tax cuts and other incentives for these companies. The government sees smaller companies as vital to the nation’s economy and has been encouraging the growth of a corporate bond market as part of its long-term effort to develop and strengthen the country’s financial system.
The bond business continues to grow rapidly. In 2011 and 2012, 572 SMEs borrowed a total of about 315 billion yuan on the bond market, almost four times the amount they raised in the three years between 2008 and 2010, according to China’s National Association of Financial Market Institutional Investors (NAFMII).
SMEs accounted for just a fraction of the 5.87 trillion yuan in bonds issued by all Chinese entities in 2012, according to the China Central Depository Clearing Co. Yet that was significant for a market in which most finance goes to the central government, big state-owned enterprises, the government’s policy banks and local government financing platforms. Those four sectors accounted for roughly three quarters of all issuance last year, according to the association.
The bond market has been increasingly filling a void left by credit-shy banks, which since 2011 have slowed the pace of lending in response to government macroeconomic controls aimed at preventing the economy from overheating. Guotai Junan Securities reported strong demand for corporate bonds and notes in March of this year, when 57 state-owned enterprises (SOEs) and four SMEs issued bonds. Net bond financing for all enterprises, including SMEs and the state-run giants, jumped to 190 billion yuan in April from 101 billion yuan in April 2012, the People’s Bank of China reported on May 15.
Traditionally, many bond market investors have been reluctant to wade into the SME sector. Those borrowers “mainly are smaller-scale, privately owned companies which do not obtain any government support,” explains Chris Lau, a portfolio manager at Hong Kong–based Bosera Asset Management (International) Co., whose mainland parent company is one of the biggest investors in enterprise bonds, or debt issued by China’s big state-owned companies. The Hong Kong outfit has a 31 billion yuan quota to invest in mainland markets under China’s Renminbi Qualified Institutional Investor (RQFII) program; it invests mainly in short- and medium-term notes, corporate bonds and enterprise bonds but does not have “much exposure in SME bonds,” says Lau.
Bosera will be a bigger buyer in the future, though. “We expect to gradually increase investment in SME bonds in the coming years,” says Lau. “Mainland SME bonds represent relatively good investment opportunities in the long run,” he adds, because the government “encourages companies to shift the source of funding from traditional bank loans to the debt capital market.”
Attractive yields provide another reason for increased interest. SME bonds, which generally have maturities of about 30 months, offered yields of 6.37 percent on average last year, according to NAFMII. By comparison, yields on the Chinese government’s recent three-year treasury bonds were in the 2.75 percent range, while in March, China Railway Corp. offered 20 billion yuan of five-year bonds at a rate of 4.5 percent. It was the company’s first bond issue since it was spun off from the Ministry of Railways.
Private companies issuing SME bonds include manufacturers of consumer staples, electronics, environmental products and producers of chemicals and raw materials. It’s rare for an SME bond to carry a rating higher than single-A.
To help offset the increased credit risk, underwriters sometimes combine two or more SMEs into a single issue, known as an “SME collective bond.” In July 2012, Industrial and Commercial Bank of China (ICBC) sold 230 million yuan of three-year bonds collectively on behalf of Shanghai Debang Logistics Co. and Shanghai Wantai Aluminum Co. The two companies were rated A and BB+, respectively, by Shanghai Brilliance Credit Rating & Investor Service Co.
Mainland retail investors can access SME bonds through wealth management plans sold by banks. In addition, insurance companies have been stepping up their participation in the SME bond market, according to NAFMII.
The SME bond sector should get another boost this month from the Shanghai and Shenzhen stock exchanges. The bourses plan to introduce the first Chinese platform for high-yield bonds, which would raise cash specifically for smaller companies that aren’t listed on either exchange. The new platform is designed to “expand financing channels” for SMEs, to “support the development of the real economy and protect the legal rights and interests of investors,” the Shanghai Stock Exchange said in a statement.
A wider investor base should help the SME market to develop. As of last year about half of all outstanding SME bonds were held by banks, according to NAFMII. A recent report from the association said including SME bonds in a diverse portfolio carried “relatively low risk” for investors.
