Chinese companies are feeling the heat from US$668 billion of nation’s puttable bond cooker

It seemed like a good idea at the time, but now an incentive that helped sell US$668 billion of corporate bonds to Chinese investors is coming back to haunt borrowers.

They’re embedded put options, a feature that lets debt holders demand repayment, typically after interest rates rise. With borrowing costs ticking higher amid Beijing’s squeeze on debt, one company has already defaulted this month after investors requested they be paid back early.

Ratings companies are warning there’s more to come with China accounting for about 69 per cent of all the puttable notes worldwide, according to data compiled by Bloomberg.

“We expect onshore bond defaults to rise this year as liquidity tightening and high funding cost are hurting weak companies’ refinancing,” said Christopher Lee, managing director of corporate ratings at S&P Global Ratings in Hong Kong. ‘Bondholders may be increasingly likely to exercise their put options as credit quality of the issuers deteriorate.”

After leveraging its way out of the global financial crisis, China is cracking down on excessive and speculative borrowing amid concern it poses risks to the financial system. The campaign has driven up costs across the corporate bond market, with yield spread on AA- notes, considered junk in the nation, up 63 basis points from a low reached on October 30, to near the highest since June last year. That’s a challenge for companies engaged in debt refinancing.

Companies to watch out for in the coming months will be developers as they face the highest pressure among all sectors for early redemptions with 870 billion yuan (US$137 billion) of puttable bonds outstanding, Bloomberg-compiled data show.