In mid-April 2020, a new financial crisis was underway.
Emerging market Asia high-yield US dollar credit had fallen by 7.9 percent year-to-date, while US corporate high-yield credit had dropped by 9.17 percent within the same time frame.
On a one-year return basis, Indonesia high-yield US dollar credit plunged 16.58 percent, while India high-yield US dollar credit was down by 4.26 percent. China high-yield US dollar credit, however, remained flat.
New issues in the onshore market were especially strong during January and February, and for a brief period following the Chinese New Year celebrations, deals were made in spite of the intensifying spread of the virus and subsequent global economic fallout. At a virtual roundtable hosted by GlobalCapital and Standard Chartered in mid-April, industry leaders discussed the uniqueness of China’s high-yield bond market. Present at the discussion were executives representing issuers, investors, banks and ratings agencies.
Liquidity, agility and investor appeal
From the advent of the COVID-19 crisis, market commentators were quick to compare it to the global financial crisis of 2008 and Asian financial crisis of 1997, where liquidity came to a standstill across the region. Today, however, matters are different.
Back then, Asia’s investor base was not as large or liquid as it is today. “If you think about the wealth that exists now in Asia, this is from people and companies that make money in the region,” explained Fredric Teng, head of high yield, capital markets, Greater China and North Asia at Standard Chartered.
“They are investing in bond funds and equity funds and are very comfortable with risk being deployed in the region. So there is this pool of liquidity, whether it is at the institutional, state-controlled or private levels.”
Property developers, which account for more than half of Chinese high-yield debt, are notably agile. Unlike their peers in the industrials sector, they can defer projects and reduce spending. During Q4 2019 and Q1 2020, they capitalised on favourable market conditions by front-loading much of their near- and mid-term refinancing needs.
Chinese high-yield property bonds are relatively cheap when compared to other high-yield markets. Furthermore, investors can conduct due diligence on issuers with ease, and have access to up-to-date information on sales, repayments and refinancing.
“The big names that we invest in are well run, have liquidity and access to markets, and are unlikely to face significant default risk. They are an attractive proposition because they are focused on protecting their balance sheets,” explained Simon Cooke, portfolio manager, emerging markets at Insight Investment.
Communication and transparency
Property developers, overall, are proactive in communicating the impact of COVID-19 to investors. This provides much comfort to bond holders, banks and credit agencies. Many issuers publish weekly updates on how they are managing their businesses during the lockdown, and how they plan to resume operations once when the crisis fully clears.
“Proactive dialogue is essential,” quipped Kenny Chan, chief financial officer at Zhenro Properties Group.
More importantly, issuers are disclosing their liquidity positions. Unlike previous crises where property developers experienced decreases in economic activity, the COVID-19 crisis ceased all sources of income. To reassure investors on their cash positions — as well as capitalise on falling bond prices — some are conducting buy-backs.
“Issuers are buying back short-dated bonds as they believe it is opportunistic to do so. Simultaneously, they are sending a message to investors that they have the ability to step up during volatile times,” said Eugene Fung, senior portfolio manager, head of credit and equities at BFAM Partners.
Not all companies are in a good place, however. Smaller and lesser-known property developers with immediate refinancing needs are particularly vulnerable, as is the industrials sector as a whole.
Diversification and government support
Accessing multiple sources of funding has been key to the growth of China’s high-yield bond market, and will remain so going forward. Large developers, in particular, must diversify their sources of liquidity and maximise their funding channels.
Issuers can raise debt in the onshore market in renminbi or in the offshore market in US dollars. Additionally, they can purchase loans in either. In the onshore market, loans are cheaper than bonds, yet their covenants are typically demanding on borrowers, restricting the proceeds to certain activities. Similarly, bonds issued in the onshore market can only be used for refinancing purposes by property developers.
Bonds issued in the offshore market are less restricted but come at a cost. “Some property developers have held offshore bonds trading in the 20 percent yield range while their onshore bonds were trading at below five percent,” noted Gerhard Radtke, partner at Davis Polk & Wardwell.
“While this illustrates structural differences, it also demonstrates the great lengths to which the Chinese regulators have gone to provide liquidity to the market.”
In early April, the People’s Bank of China pumped RMB 2.87 trillion (US$405 billion) into the Chinese economy through loans issued by state-owned banks. Many property developers have benefited from this stimulus.
Emerging opportunities and risks
As the lockdown eases, opportunities for investors in China’s high-yield bond market will emerge over the short and longer term. “One is where issuers have had limited exposure to the COVID-19 pandemic but have sold-off significantly.” said Cooke. “Another involves issuers that are impacted by the crisis but will be able to withstand it.”
Property developers are also optimistic. Recent measures introduced by the Chinese government have been favourable to onshore issuers, and more support is expected. “We should be able to access lower interest rates in China going forward,” enthused Lawrence Leung, head of capital markets and investor relations at Cifi. Property developers anticipate funding costs will come down, providing they hold good working relationships with their banks, and have a good track record in the capital markets.
While new opportunities are emerging on the mainland, caution must be exerted elsewhere. “Liquidity is a worry in the offshore market,” said Adrian Cheng, senior director, Asia Pacific corporates at Fitch Ratings. Bonds issued by Chinese companies overseas with maturities of more than one year require approval from the National Development and Reform Commission — approval that is unlikely to be granted in light of high market volatility experienced globally.
“Going forward, it is going to be quite difficult to raise US dollar bonds, unless issuers rely on 364-day bonds where they do not need regulatory approval. But the market has to be right for them,” Cheng added.
As the Chinese government gradually eases its COVID-19 lockdown, and as the nation’s economy recovers, issuers of onshore high-yield property bonds and their investors should gain yet more, as the attractiveness of the asset class grows further among the global investment community.
Read the full article on the discussion here.