2
Asia Pacific Equity Research
02 July 2018Katherine Lei(852) 2800-8552
katherine.lei@jpmorgan
Table of Contents
Chart talks: The shock and benefit of corporate bond
defaults..3
Investment Summary...5
Corporate bond defaults: Just the beginning...........5
Profiling the defaulted bonds issuers7
Assessing the credit risk of corporate bonds in China.........11
Impacts from latest regulatory tightening...13
Defaults are positive for China’s financial market development in the long run......14
Profiling China’s corporate bond markets...16
Onshore corporate bond market.....16
Offshore corporate bond market....18
Analyzing the underlying credit risk of corporate bonds in
China...22
Debt at risk ratio could be 1.5-6.0%, implicit guarantee is the key swing factor......23
Impacts on macro.....26
Impacts on banks and brokers..........30
Quantifying losses for banks and brokers in each scenario..30Asia Pacific Equity Research
02 July 2018Katherine Lei(852) 2800-8552
katherine.lei@jpmorgan
Chart talks: The shock and benefit of corporate bond defaults
Why is corporate bond default ratio low despite recent upward trendDefault ratio has been rising to 0.6% for onshore
bond, still low when compared to banks corporate NPL ratio (2.4%).A probable explanation to the low default ratio is the
high concentration of State-owned enterprises(SOE) bond issuers in onshore market.(Note: DAR ratio or cumulative
default ratio for corporate bond is similar to concept on NPL ratio of banks.New default ratio is similar to NPL formation
ratio).
Figure 1: China: outstanding corporate bond
Source: WIND, J.P. Morgan. Note: 1Q18 4Q-rolling GDP is applied for 5M18 data.
Figure 2: Outstanding of China USD Bond
Source: J.P. Morgan. Data as of Jun 19th, 2018
Table 1: On-shore corporate bond breakdown by ownership of
issuersas of May 2018, ~85% of corporate bonds are issued by SOE
Corporate bond breakdown by ownership of issuersAs of total
Local SOEs (地方国有企业)56%
Central SOEs (中央国有企业)29%
Private enterprises (民营企业)10%
Foreign-owned enterprises (外商独资企业)2%
Sino-foreign joint ventures (中外合资企业)1%
Other enterprises (其它企业)3%
Total100%
Source: WIND.
Figure 3: Onshore China corporate bond: cumulative default ratio
Source: WIND, J.P. Morgan. Note: default ratio is calculated by period-end outstanding
defaulted corporate bond / period-end outstanding corporate bond. 2018YTD refers to period up
to June 1.
Figure 4: Onshore corporate bond: default formation ratio has picked
up in 2018, similar to banks’ bad debt formation ratio
Source: WIND, J.P. Morgan. Note: default ratio is calculated by (new defaults –resolved cases
in the period) / beginning balance of outstanding corporate bond. 2018YTD refers to period up
to June 1.
Figure 5: Newly default ratio of China offshore USD high-yield
corporate bondhas picked up in offshore market in 2018, similar
trend to onshore market
Source: WIND, J.P. MorganNote: this is flow concept as it capture newly defaulted bond
balance / existing total bond balance.
0%
10%
20%
30%
0.0
5.0
10.0
15.0
20.0
20112012201320142015201620175M18
AAAAA+
AAAA- and below (or no rating)
Corp bond outstanding/GDP
Corpbond outstanding-Rmb trnAs % of GDP
10 10 9 8 8 11 19 35 67
135 193
236 321
342
2 3 5 5 5 12 21 30
48
57
56 64
94 110
12131513132340
65
115
192
248
300
416452100
200
300
400
500
2005200620072008200920102011201220132014201520162017Jun
2018
in USD Bn
IGHY
0.0%
0.1%
0.2%
0.3%
0.4%
0.5%
0.6%
0.7%
20142015201620172018YTD
Default ratio
0.00%
0.05%
0.10%
0.15%
0.20%
0.25%
0.30%
20142015201620172018YTD
Default formation ratio
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
2015201620172018YTD
Default Ratio of offshore China bondAsia Pacific Equity Research
02 July 2018Katherine Lei(852) 2800-8552
katherine.lei@jpmorgan
What is the underlying quality of corporate bondsOur analysis shows that potential debt-at-risk (DAR) ratio at stress
scenario could reach 6% basedon bond issuers’ financial data ending 2017. This has declined from 11% at 1H15.
Nonetheless, the 6% DAR ratio is unlikely to manifest into actual default ratio.Note that Central and local SOEs have
significantly higher DAR ratio, but low actual default ratio.
Figure 6: Potential debt at risk ratio at worst-case scenario could be
6%, but the trend has improved from 1H15
Source: J.P. Morgan estimates. Note: worst case scenario assumes issuers are not able to
service interest in high stress scenario and there are no bailouts.
Table 2: Potential worst-case debt-at-riskratio by sectors, we noted
significant improvement for Manufacturing, Mining & Wholesale &
Retail sectors, likely due to supply side reform
1H15201520162017YoY
Agricultural & forestry14.6%12.4%12.3%11.3%-1 ppt
Financials3.6%3.4%5.5%5.4%0 ppt
Manufacturing24.0%22.7%17.4%15.6%-2 ppt
Mining21.1%18.4%12.9%8.5%-4 ppt
Property4.8%1.4%1.1%0.8%0 ppt
Transportation4.5%2.6%2.2%3.1%1 ppt
Utilities13.0%14.8%17.0%18.4%1 ppt
Wholesale and retail13.3%15.5%13.6%6.4%-7 ppt
Total11.2%7.3%6.4%6.0%0 ppt
Source: J.P. Morgan estimates. Note: this is based on corporate bond o/s as of May 2018 using
financial datain each period.
Figure 7: Worst-case scenarioDAR ratioby bondissuersownership
–SOEs have higher DAR ratio
Source: WIND, J.P. Morgan estimates. Note: worst case scenario assumes issuers are not able
to service interest in high stress scenario and there are no bailouts.This is basedon financial
data as at end 2017 for corporate bond outstanding as at May 2018
Figure 8: Actual cumulative default ratios of corporate bonds by
issuers’ ownership
Source: WIND, J.P. Morgan estimates. Note: default ratio is calculated by period-end
outstanding defaulted corporate bond / period-end outstanding corporate bond. 2018YTD refers
to period up to June 1.
If corporate bond default ratio rises materially,this could signala reductionin government intervention and the beginning
of SOE reform, in our view. Rising credit spread is positive forbanks with strong risk management.
Figure 9: China's onshore corporate bond has been much flatter than
US’. Rising bonddefault ratio could improve credit spread in China.
Source: Bloomberg, WIND
Figure 10: Negative impact on banks’ 2018e earnings if corporate
bond default ratio rise to 6% in one year and banks choose to bailout
their WMP investors
Source: Company data, J.P. Morgan. Note: we assume 30% of banks’ off BS WMPs invest in
corporate bond.
13.4%
11.2%
7.3%6.4%6.0%
0.0%
5.0%
10.0%
15.0%
1H15201520162017
Worst case scenario - debt at risk ratio based on bonds o/s Nov. 2015Worst case scenario - debt at risk ratio based on bonds o/s May 2018
1.9%
2.9%3.6%
5.7%
8.1%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
Foreign owned
enterprises
Sino-foreign
joint venture
Private
companies
Local SOECentral SOE
Potential debt at risk ratios by bond ownership
Weighted average debt at risk ratios by outstanding bond balance
0.2%0.2%
2.6%
4.3%
5.6%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
Central SOEsLocal SOEsForeign-owned
enterprises
Private
enterprises
Sino-foreign joint
ventures
Default ratios 2018YTD by sectorsDefault ratios 2018YTD200
400
600
800
1000
1200
1400
Jan
-14
Apr
-14Jul-14
Oct
-14
Jan
-15
Apr
-15Jul-15
Oct
-15
Jan
-16
Apr
-16Jul-16
Oct
-16
Jan
-17
Apr
-17Jul-17
Oct
-17
Jan
-18
Apr
-18
Credit spread: Chi