Standby letters of credit (L/Cs) issued by Chinese lenders to guarantee corporate US dollar bond sales are contributing to the issuers' own default risk according to a leading investment manager.

The L/Cs also appear to be factor that will not help the worrying level of bad loans by Chinese lenders which have surged to the highest since 2008, whilst default risk is climbing at the fastest pace in Asia.

L/C contributions

Several recent standby L/Cs are thought to have the potential to contribute further to China's burgeoning bad loan book.

They include the Bank of China's backing of US$500 million of securities sold by China Shipping Group Co and Agricultural Bank of China's support for a US$300 million issue by Beijing Energy Investment Holding Co.

Credit-default swaps

Bad loans in the world's second-largest economy have prompted credit-default swaps on China Development Bank Corp, Export-Import Bank of China and Bank of China to increase the most in Asia this year.

Concerns over the potential negative impacts of standby L/Cs on Chinese lenders themselves as well as on the bonds they back have now been expressed by the Hong Kong-based investment director at Fidelity Worldwide Investment, Gregor Carle.

Investor's view

"If the credit-support provider's fundamentals are weakening, that should translate to a weakening in fundamentals of the bond," he said.

Fidelity Worldwide Investment managed more than US$270 billion of investments at the end of 2013.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.