Junk Bonds Come To China

Shanghai Stock Exchange

Shanghai Stock Exchange (Photo credit: Wikipedia)

During the decade of the 1970s in the United States, the Dow Jones Industrial Average (DJIA) was stuck at the 800 level, common stock offerings were few and far between, and companies with debt ratings lower than single “A” could not issue bonds. That meant that small and medium-sized enterprises (SMEs), the key job creators in any economy, had few choices when it came to accessing capital to finance the growth of their businesses.

Because SMEs were effectively locked out of both the public equity and bond markets, most turned to the commercial banks, which were, by far, the largest providers of capital during that period. Before the consolidation of the banking industry that began in the late 1980s, there were about 13,000 independent banks in the United States, compared to less than half that number today. The local banks, which depended on business from the communities they served, had a strong vested interest in making loans available to the companies in their area.

Bank loans had two shortcomings, though. First they were of short duration and many could be called at any time by the bank, making it difficult for a company to plan for the long term. Second, interest rates were variable, which is fine in a low interest rate environment, but which could be very destabilizing for a company when interest rate spiraled upward, as they did in the 1970s. By the beginning of 1981, the bank prime lending rate had reached 20 percent, causing Art Buchwald, the famous American humorist and writer, to quip that 1980 would go down in history as the year when it was cheaper to borrow money from the Mafia than the local bank.

The development of so-called “junk bonds” by Michael Milken and Drexel Burnham Lambert in the 1980s transformed the way in which SMEs and companies with lower credit ratings could access capital in the United States. While bank lending remained an important source of financing, companies of all sizes and all credit ratings had the option of accessing the bond markets, and a different universe of creditors, by the end of the 1980s through the issuance of high yield securities.

SMEs in China have historically had it even tougher than their counterparts in the United States. China’s state-owned banks dominate the country’s commercial banking industry, and they have always found it easier to lend to other state-owned enterprises than to private companies and SMEs. As a result, private companies have been forced to borrow from underground finance companies at often usurious interest rates.

In an effort to help cash-starved private Chinese firms find credit, the Shanghai Stock Exchange began to issue approvals for companies to begin issuing “junk bonds” in June. A statement issued by the exchange approved seven Chinese companies to issue high-yield bonds via private placements to qualified investors. The bonds may then be bought and sold, under certain conditions, on Shanghai’s fixed-income trading platform.

Xie Hongguo, the founder and president of Nine-Star Technology, a company which makes and sells financial capital software and is growing at 30 percent per year, was one of the first to sign up. “This is great news for small and medium enterprises,” Xie said. “Before, when companies like us needed to get capital, there were only two ways.” One way was to issue stock, which effectively means giving up a share of your company. The other was going to banks, which often require physical collateral that a software company generally doesn’t have. “When neither of those would work, we would go to loan sharks,” he said, “which is burdensome, and very, very dangerous.” According to Xie, the loan sharks, or shadow banks, charge interest rates that average around 21 percent — and it’s not pleasant for borrowers when they don’t pay back on time.

As a small, private business owner, Xie is very pleased by this latest development in China’s capital markets. “I would say this junk bond is the first capital tool in the Chinese market that doesn’t have to be approved by the government bodies. You only have to register. This is very interesting to us.” The interest rate on Nine Star Technology’s newly issued junk bonds is 8.5 percent, slightly higher than a bank loan. With respect to amount, Xie said, “We asked for $1.5 million and sold out in less than a day.”

China’s bond market is much less developed than that in the United States. Currently, 80 percent of bonds issued are based on State credit and most of the rest are from AAA or AA-rated large enterprises. China’s total bond balance of 22.1 trillion yuan ($3.5 trillion) at the end of 2011 is only one-tenth of the $36 trillion of bonds outstanding in the United States.

Analysts expect about 4 billion to 5 billion yuan ($630 million to $787 million) in high-yield bonds to be issued in 2012, growing quickly to around 100 billion yuan ($15.8 billion) in the following year. The market could be comprised of more than 300 billion yuan ($47.2 billion) worth of outstanding high-yield bonds by 2015, they said.

Enhanced by Zemanta

No comments yet... Be the first to leave a reply!