Upgrade-Happy China raters say S&P lacks local knowledge in cuts

[BEIJING] China's economy is growing at the slowest pace in 25 years, total debt is almost three times output and twice as many listed companies are losing money as a year ago. Apparently, that doesn't faze the nation's rating companies.

Three of the largest local ranking firms have handed out 190 upgrades and 46 cuts to local companies this year. By contrast, the big three overseas institutions have raised 36 ratings and lowered 62. Bank of Nanjing Co was elevated to AAA by Chengxin International Credit Rating Co in May and downgraded to junk by Standard & Poor's a month later.

Dagong Global Credit Rating Group says foreign companies grant unfair assessments due to a lack of local knowledge, while China Lianhe Credit Rating Co. argues that not all companies will suffer in an economic slowdown. Lianhe acknowledges that pressure to reward companies with grades that allow certain funds to buy can cause inflated assessments. S&P and Moody's Investors Service say that corporate outlooks can only worsen as the economy falters.

"It seems bizarre that credit ratings are generally upgraded at this time of a slowing economy," said Alex Gardner, a Hong Kong-based analyst at Bloomberg Intelligence. "Large divergences in ratings mean that pricing bond yields for local and international investors will be more confusing. If there is confusion about how to price debt, then investors will not make well-informed investment decisions and may ultimately lose money." Government, corporate and household obligations ballooned to US$28.2 trillion, or 282 per cent of China's gross domestic product, as of mid-2014, according to McKinsey & Co. About 16 per cent of companies listed on the Shanghai stock exchange generated losses in the last 12 months, more than double the number of a year ago, Bloomberg-compiled data show. The number of Chinese publicly traded firms with net losses, declining revenue and net debt that is more than 150 per cent of equity jumped to 65 as of June 30 from 49 at the end of last year, according to data compiled by Bloomberg. The bond market is pricing a higher risk of defaults after cases of non-payment. Seven-year AA- corporate notes now yield 5.89 per cent, 113 basis points higher than a record low of 4.76 per cent in December 2008, ChinaBond data show. Baoding Tianwei Group Co, the power-transformer maker that became the country's first state-owned company to renege on a domestic bond in April, was rated the equivalent of investment grade by Lianhe less than five months before the failure. State-owned China National Erzhong Group Co may miss an interest payment later this month after one of its creditors filed a restructuring request, the smelting-equipment maker said in a statement Tuesday.

Concern that China's economy will weaken further adds risk to credit profiles and there will probably be more defaults, said Terry Chan, Melbourne-based managing director for corporate ratings at S&P. The New York-based grader gave Chinese companies 26 downgrades versus 14 upgrades this year, it said in an e- mailed statement on Sept 7. Moody's lowered ratings for 24 and increased 17, while Fitch Ratings cut 12 and upgraded five.

"Chinese companies' performance has been and will be pressured by weak demand and over-capacity in some sectors," said Clara Lau, Hong Kong-based group credit officer at Moody's. "There will be more negative rating actions than positive." More Competitive Beijing-based Dagong, which raised 44 ratings and lowered 18, said it increased assessments for firms whose sources for repayments are stable. Lianhe, which gave nearly six times more upgrades than the other way around, argued that companies' profitability improved and they became more competitive.

Dagong says its judgment is significantly different from that of foreign assessors. Socialist China has been much more stable than developed capitalist countries, and its steady political environment and the central government's strong fiscal power facilitates a gradual and smooth economic restructuring, it said in an Aug 28 e-mailed statement.

"Foreign rating institutions lack knowledge about China's fundamental conditions," it said. "It is very hard for them to make meaningful rating decisions because they are over-dependent on companies' financial criteria without thorough understanding and judgment of qualitative factors." China Minsheng Banking Corp, which reported a first-half net profit that missed analysts' estimate and nonperforming loans that jumped to 1.36 per cent at end-June from 0.93 per cent last year, got an upgrade to a AAA by Dagong on Aug. 19. The Beijing-based lender is rated junk-level BB+ by Fitch and BBB by S&P, according to data compiled by Bloomberg.

China's National Development and Reform Commission will scrap quotas for overseas bond sales and medium- to long-term global commercial loans, and only require registration in an effort to support the real economy and facilitate cross-border financing, it said in a statement dated on Monday.

The performance of industries that aren't sensitive to economic cycles, such as those involved in highways, airports and transportation, and those with strong sentiment and enhanced profitability like in the electricity business have been on a positive trend, according to Lianhe.

"Some companies have expanded their capital base and their capital structures have improved," Lianhe said in an e-mail. "So their profitability and competitiveness are stronger. Thus their ratings will be lifted."

The China Securities Regulatory Commission said in January that companies need an AAA rating to sell exchange-traded bonds to public investors - or individuals with less than three million yuan of financial assets. The China Securities Depository and Clearing Corp. said in December that exchange-traded notes rated lower than AAA can't be used as collateral for short-term loans because they're too risky.

"In order to meet the regulators' gradings requirements to be traded in the bond market and to be bought by investors, issuers will necessarily put pressure on credit rating companies," Lianhe said.

Data on ratings fees in China are elusive as some issuers don't publish the information. Only recently have some local authorities started disclosing the charges on government websites.

"I believe the best way to access a company is always through your own analysis as opposed to just relying on external help," said Raymond Chia, Singapore-based head of Asia ex-Japan credit research at Schroder Investment Management Ltd, which has its own in-house rating unit. "We use rating agencies as a guide but it should never be used as the Bible."

BLOOMBERG