When Estella Ng, chief financial officer of Guangdong-based property developer Country Garden, turned her eye to the bond markets early this year, she saw an opportunity for the company to strike first and take advantage of abundant liquidity.
Unlike past years, when the bond markets were opened by sovereign or blue-chip borrowers such as the Republic of the Philippines, Hutchison Whampoa, or Export-Import Bank of Korea (Kexim), in 2013, it was the bellwether Chinese developer, along with its smaller peer, Kaisa, that set the ball rolling.
Country Garden, one of the biggest mainland developers and majority-owned by Yang Guoqiang, one of China’s richest people, embodied all the reasons why mainland developers were rushing offshore: rates are low enough for issuers but high enough for investors hungry for yield. The chance to raise funds cheaply was too good to resist.
“The fiscal cliff is resolved while interest rates and US Treasuries are very low. We decided to take advantage of this and issue a 10-year bond for the first time. Now is a good time for high-yield borrowers to tap the market,” said Country Garden’s Ng in a phone interview with FinanceAsia. “We expect the dollar bond market to remain robust in the next 18 months, but there could be bouts of volatility, so it makes sense to be the first mover,” she added.
If 2012 was the year for plain vanilla, the stage is set for junk borrowers to come to the fore in 2013. According to Dealogic, Asian high-yield borrowers raised $10.6 billion in January, a record start to the year and more than two-thirds of the $15.3 billion raised from Asia ex-Japan during the whole of 2012.
Chinese developers defined high-yield issuance in January ― accounting for over half of the total high-yield bonds issued.
For chief financial officers like Ng, the motivation to tap the bond market was compelling. Back in February 2011, the developer issued a $900 million seven-year bond that paid an 11.125% coupon. Two years later, it returned with a $750 million 10-year bond that paid a 7.5% coupon. Little wonder that CFOs around the world were turning to bonds for funding.
Some of the deals on the table were plausibly the best they would see in a lifetime. But there were other fundamental shifts at play as well. In 2012, companies became less reliant on bank lending and shifted to public debt markets. Many had learned, rather painfully, during the global financial crisis of 2008 that banks could pull the plug on lending quickly.
“Asia has become less of a savings region. As a result, Asian banks are no longer a bastion of liquidity. The bond markets have grown and a big part of that is because bond markets have replaced bank lending as a source of funding,” said Viktor Hjort, head of Asia fixed income research at Morgan Stanley.
Chinese developers have long grappled with a lack of bank financing, and face severe restrictions on the use of onshore bank borrowings to purchase land. When the high-yield market was shut, many of these developers were forced to turn to trust financing at usurious rates or go underground.
Now, markets are open. And the mantra among these cash-hungry developers was clear: take money off the table now. Country Garden’s $750 million bond was 24 times subscribed. Scores of other Chinese developers saw this, sat up and decided to follow suit. Following in its footsteps, other Chinese developers, including Shimao Property, Hopson Development, Agile Property, China SCE Property, Central China Real Estate and Longfor Properties have tapped investors for money.
The torrent of supply is very much driven by dynamics between the onshore and offshore bond markets. China is the world’s second largest economy and any shifts in onshore lending have a direct impact on the region’s debt markets.
“Chinese corporate debt accounts for about 40% of the debt in the region. China is the elephant in the room. It doesn’t take very much for a change in lending habits to lead to a flood of supply,” said Hjort.
Concerns emerge
A number of the Chinese property bonds have pushed the boundaries in Asia junk and tested investor appetite for credits lower down the curve. Hopson Development, for instance, issued the first triple-C rated dollar bond seen in Asia in a long while. It was quickly followed by Powerlong Real Estate and Greentown China. While Triple C debt is prevalent in the mature US high-yield market, it is not common in Asia.
While Country Garden’s deal sold well, later deals were met with muted demand and even outright resistance. Faced with a wall of supply, investor enthusiasm for Chinese paper began to wane. Analysts were also turning less positive on the sector as a whole.
“Since 2011, we have favoured the China property sector. But starting this year, we downgraded our view on the China property sector from ‘overweight’ to ‘neutral’ on concerns over further supply,” said Hjort.
The concerns among fund managers percolated around valuations and bond structures. After a stellar run in 2012, few expect high-yield to post the same returns in 2013.
There are also concerns about perpetual bond issues sold by Chinese property companies. Such bonds are risky as they have no maturity, borrowers can defer coupon payments, and they are lower in the capital structure. They allow companies to protect their ratings and keep their gearing levels down, but are more expensive to issue than senior debt.
Agile Properties in January issued a $500 million perpetual bond that traded poorly in secondary markets. Following that, another Chinese developer, KWG Property, attempted to issue a perpetual, but chose to pull the deal amid poor demand. It later opted for a senior bond.
“The risk and return for high yield is getting ahead of fundamentals,” said Arthur Lau, head of fixed income for Asia ex-Japan at Pinebridge Investment. “We do not expect a surge in default scenarios in China as the economic situation has improved. But taking into account the near-term volatility, we feel that investors are not sufficiently compensated, especially with regard to bond structures.”
“Investors are not looking at the structure of perpetuals closely and carefully enough. Some of these perpetuals are potentially subject to a high non-call risk,” said Lau. “If down the road economies improve and the US starts to raise rates, an investor could be sitting on a low-yielding bond that is very difficult to get rid of. Investors need to look beyond the near term.”
Love it or hate it, January set new records for junk issuance. Ultimately, bond markets are driven by the inevitable push-pull between companies and investors. Investors chase returns and companies push for the most competitive pricing, sometimes at the risk of alienating the investor base they are dependent on. The banks on the other hand, pocketed healthy fees from the slew of junk bonds. But the lingering question on everyone’s mind is: how long will the party last?
This story initially appeared in the February 2013 issue of FinanceAsia magazine.
