Jun Pan, Professor of Finance at Jiao Tong University, has a flair for insightful communicaton and is an expert researcher of Chinese corporate bond markets. In a recent paper she analyses whether the spreads in China’s corporate bonds appropriately reflect the risk in companies.
• China’s corporate bond market (locally and USD denominated) went from nonexistant to $3tril in the last ten years. Market traded debt vs bank loans in 2008 was 4.6%; it was 19% in 2018.
• Professor Jun explains simply the Merton model for credit risk and shows how no link to fundamental of the companies to risk in credit spread was found due to implicit government guarantees, which has changed recently.
• The credit market can be summarized in three phases: 1 pre-default; 2 post-defult up to 2018, where the spread between state-owned and private companies was still 20bps; post-2018, where spreads widenend significantly and one state-owned enterprise in Tianjin proposed a 64% haircut for bond investors in what could amount to the first de facto default by an SOE in more than two decades.
Why does this matter? Chinese bond markets are opening up and becoming increasingly friendly to international investors. Future developments on regulations and fungible funding between SOE and non-SOE companies (to be reflected via difference in credit spread) can provide an excellent opportunity to participate in real Chinese growth. In a world of low yield, Chinese corporate bond sector provides a diversified source of alpha.
For access to our Slack Chat Room, where we discuss all things markets with our researchers and subscribers