HONG KONG (BLOOMBERG) - Chinese companies challenged by policymakers' determination to tamp down leverage in the country's financial system have found some creative ways to secure funding.
One of the least transparent mechanisms to emerge so far is a tactic where bond issuers are indirectly buying their own bond offerings, according to investors and bond and credit-rating analysts. The idea is to inflate issuance sizes, creating the image of greater access to capital than might otherwise be true - and leading to lower coupons in subsequent sales.
Market players began picking up on the practice, known as structured issuance, when the deleveraging drive intensified a couple of years back. While loath to name names, some warn that the practice increased late in 2018 as default fears spread. For investors, it's one more idiosyncrasy in the world's third-largest bond market to consider when moving beyond government debt.
"The motive of using the structured financing method is to boost market demand for bonds the issuer is selling - and it will benefit future issuance as well," said Li Chang, an analyst at S&P Global Ratings in Beijing.
The practice is one of several strategies for debtors to enhance their appeal to creditors, including one where borrowers guarantee each others' debt.
The National Association of Financial Market Institutional Investors, a regulator of China's bond market, didn't reply to an emailed request for comments by Bloomberg. The China Securities Regulatory Commission didn't respond to faxed enquiries. The National Development and Reform Commission didn't immediately reply to a faxed request for comment.
Lower rated private companies and local government financing vehicles, or LGFVs, have been the main users of structured issuance, observers say. One popular method is for the borrower to put up the money for the subordinated tranche - the first to absorb losses - of the asset-management vehicle that buys the bonds. Li at S&P said this then exposes buyers of the senior tranche to greater risk in case of default.
The overseers of the asset management vehicle benefit from the arrangement because it helps expand their products and boost fees, Everbright Securities Co analyst Zhang Xu wrote in a research note. The mechanism has been "crucial to restore market confidence" for some weak issuers, Zhang wrote, declining to specify the names of any companies involved.
Zhou Hao, president of China Chengxin International Credit Rating Co, also declined to name names, but said many private firms had drawn money from "their own pockets" to help sell their bonds - leading to less net proceeds being raised.
Companies are likely to find continuing pressures when it comes to financing in 2019. S&P Global Ratings said this week that corporate defaults "will continue to increase modestly", while debt servicing is set to become more difficult.
China's policymakers have taken steps to support the flow of credit both to private companies and local authorities in recent months in an effort to arrest an economic slowdown. And there's evidence of renewed investor demand for Chinese high-yield securities. At the same time, the central bank has repeatedly said it won't embrace a flood of liquidity, suggesting some borrowers will continue to battle for funding - and may be tempted by the structured-issuance route.
"Such non-market-based approaches cover up credit risks and interfere with investors' judgment," said Yang Xin, an investment manager at AJ Securities Co. in Shanghai. "Structured issuance is likely to increase default risks in the LGFV sector, and institutions serving as conduits will also be likely to face potential losses."