China papers over cracks with yet more rate cuts

The spotlight has been on China in recent weeks with the renminbi’s devaluation on August 11 casting a huge shadow on the country’s economic growth. The scrutiny intensified when the Caixin/Markit Manufacturing PMI Index fell to a six and a half year low of 47.1 in August, which culminated in a global stock market rout on August 24.

The dire state of affairs prompted the People’s Bank of China into action. China’s central bank cut its one-year lending rate by 25bp to 4.6% and lowered the required reserve ratio (RRR) by 50bp for banks on August 25. But participants in Asia are so far nonplussed by the PBoC’s measures.  

“This is the fifth cut since November 2014 already, and the more the PBoC does, the less of an impact it will have,” said an asset manager. “It’s better than nothing, but there won’t be any real, material change.”

While the problems might have stemmed from China, its impact has been far reaching and the entire region has suffered as a result. Bonds, for example, have taken a heavy beating this week with the Markit iTraxx Asia ex-Japan Investment Grade Index widening 9bp to 139bp.

That added to the woes of investment grade bonds as yields had already spiked 20bp since the start of the month. And the less said about high yield the better. Month to date, high yield bonds have widened around 130bp.

The asset manager thinks market conditions will continue to be volatile and the PBoC had been too hasty to act. “People need comfort, stability and assurance in times of volatility. But it just feels like the government has run out of ammo,” he added.

But one HY investor reckoned observers had been far too critical of China recently and are overreacting to the country’s every move. Whenever a negative headline hits the screen, investors panic, oversell and inject yet more volatility into the market.  

“All the headlines such as ‘record-low’, ‘market crash’ and ‘Black Monday’ are just so unfair and spawn fears more than necessary,” he said. “We should remember that China is the second largest economy in the world. It’s not an emerging market economy and is still growing 6%-7% per year.”

With yields spiking, bond bankers in the region are expecting deal flow to be light at least in the near term.

Even though September has always been a feasting season in terms of issuance, 2015 is probably going to be an exception, bankers said.

In the past, rate cuts tended to benefit high yield issuers more — Chinese property names in particular. But one DCM banker explained that all the macro volatility this year has completely killed investor sentiment for riskier credits.

He added that it would be tricky even for investment grade names to print notes now, prompting a sharp rethink in many issuers’ funding plans.

Several companies had factored in a US rate hike in September although there is now widespread talk that the US Federal Reserve could be looking at a December hike instead. All the chatter have not been helpful with injecting confidence into the market and several issuers have put their issuance on hold to await for more clarity.

Another DCM banker agreed that there will only be a handful of new issuance, most of which will be centred on stronger investment grade credits. Those are likely to come in the middle of September while issuance further down the credit curve will only have a chance once volatility recedes. 

“I’m really tired of all the red lights flashing on the Bloomberg terminals. Only when we finally see some green lights will we have a few issues from good IG names.”

While the rate cut has failed to improve sentiment on the debt front, it has coincided with the stabilisation of the region’s equities market.

Asia’s major indices – Hong Kong’s Hang Seng, Singapore’s Straits Times and Japan’s Nikkei 225 – have all traded up since the cuts were announced. The three rose 2.8%, 3.6% and 0.2%, respectively, recovering some of the ground lost on Black Monday.

It can be convenient to attribute the improvement simply to the cuts, but one Hong Kong-based ECM syndicate banker said that was far from the truth since there is typically a huge lag before the actual benefits transfer to the real economy.

In addition, the RRR cut, which is expected to pump Rmb650bn ($101bn) into the Chinese economy, has not even come into effect yet. That takes place only on September 6.

“Fundamentally, nothing has changed. It couldn’t have because the cuts were tiny and the RRR reduction hasn’t even kicked in yet,” he said. “It’s all sentiment driven, so it’s hard to say whether we’ve turned a corner or if we are still stuck in a rut.”

That was also the view take by Lim Say Boon, chief investment officer for DBS Bank.

Lim wrote in a note that the rebound was because markets globally were oversold on Monday. But since there is still plenty of uncertainty surrounding China’s currency and a lack of convincing policy measures to reverse the country’s slowdown, any recovery was going to be short-lived.

“Many markets are priced for perfection in a dysfunctional world. And the cure for that is either higher earnings or lower prices, not higher prices,” Lim wrote.

With equity valuations looking downward rather than upward, some ECM bankers are beginning to worry that their pipeline would be hit.

Bad debt manager China Huarong Asset Management is scheduled to launch its $2bn-$3bn Hong Kong IPO next month but the recent rout in equities has left its direct comparable, China Cinda Asset Management, trading at a P/B ratio of 0.85x.

This spells trouble for Huarong, one of the most highly anticipated IPOs of 2015. Chinese regulations prohibit companies from selling H-shares at below book value.

“If Huarong decides to launch soon it will have to be at a meaningful discount to Cinda of around 10%-20%. Will the regulators even let that happen?” an ECM banker questioned.

Others, however, are less worried about flailing valuations. That is because instead of using full year projected figures, they could market Huarong based on historical financials to circumvent the rules.

This tactic was used in Huishang Bank’s HK$10.1bn ($1.3bn) in October 2013 when the bookrunners sold shares at a P/B multiple of 1.02x for the six months ended June 30. On a full year basis, it would have been 0.95x, below the limit set by the regulators.

One head of ECM who is arranging the Huarong IPO said it was too early to tell whether the recent volatility will impact the primary pipeline for the rest of the year.

While things will be hit if valuations continue to deteriorate, the recent sell-off is not a good reflection of things to come as bankers reckon the declines were exaggerated because of the lack of liquidity.

It is normal for liquidity to dry up during the summer. The Hang Seng, for example, has seen its daily trading volume go down 34% from HK$165bn at the start of June to just HK$109bn on August 26.

“We don’t know if this sell-off is over yet, but I do think it’s an overreaction. Investors suddenly panicked and bolted for the door,” said the head of ECM. “But valuations in Hong Kong and China are really cheap now and I’m not sure how much lower they can go.”

“Things could be better, or they could get worse. But the key test for primary will be after September 7 when everyone is back at their desks.”