The prevalence of put options in Chinese bonds could add to funding pressures in the corporate sector over the next few years, says Fitch Ratings.
Most outstanding Chinese puttable bonds are now "in the money", owing to a tightening of market liquidity and a rise in market interest rates since late 2016. This means that issuers will either need to increase their coupon payments or make an early repayment.
Fitch does not expect puttable bonds to cause systemic stress, but some companies could face difficulties if liquidity tightens further.
Around 20% of outstanding onshore non-financial corporate bonds in China contain a put option that gives investors the right to demand early repayment of the principal. In contrast, only around 4% of corporate bonds globally are puttable.
Corporate bonds with put options issued in China are worth USD420 billion, compared with USD233 billion outstanding around the rest of the world.
The possibility of put options being exercised has become more pertinent as bond yields have risen over the last nine months. The yield shown by the ChinaBond five-year 'AAA' rated Corporate Bond Index, for example, is currently 4.7%, up from 3.5% a year earlier.
‘In the money’
Fitch’s own calculations suggest that 82% of puttable bonds are already "in the money", which means that issuers will either need to increase their coupon payments or make an early repayment.
The liquidity and refinancing risks posed by puttable bonds are partly mitigated by the inclusion of a coupon-adjustment option in almost all cases.
“We would generally expect issuers to raise coupon payments where possible to persuade investors not to exercise puts, which would allow issuers to avoid re-issuance costs,” says Fitch.
“However, it would also push up debt-servicing costs. A 100bp increase in market rates by 2019, for example, would raise interest expenses by 28% or more for 10% of issuers with bonds that have put dates in 2019.”
Time to plan for refinancing
The number of puts becoming exercisable will peak in 2018 and 2019, which gives issuers time to plan for refinancing. This makes it unlikely that puts will be a cause of systemic stress.
However, puts will shift forward the funding needs of some companies, and are likely to push up the cost of debt-servicing earlier than some companies had planned. Isolated problems cannot be ruled out, with companies that are heavily reliant on puttable bonds being likely to face pressure in the event of a significant tightening of liquidity conditions.
Where Fitch is made aware of the existence of domestic puttable bonds, its analytical approach is to treat put dates as the effective maturity dates, instead of using the final maturity dates.