Chinese G3 bonds: investors shut up shop for 2018

International bond issuance from China has entered December devoid of Christmas cheer. Issuers continue to struggle to achieve their size or pricing ambitions, and investors are itching to shut down and put 2018 behind them.  

The one exception appears to be distressed investors who are acting as if the January sales have come unseasonably early.

Traders say that they started to buy into the secondary market once yields on lower-rated Chinese credits began to hit the 14% to 15% mark in October.

Many market participants believe their presence will become more marked in 2019 given the prevailing view that spreads will continue to widen, particularly if defaults start to pick up.

Where 2018 is concerned, it may come to be remembered as a year of seconds. Or for China’s high yield borrowers, a case of second, third, fourth, fifth or even sixth helpings to try and meet their financing targets.

The constant deluge of paper has caused continuous spread widening, although some market participants believe the appearance of distressed funds signals the downturn’s bottom.

This is likely to offer very little cheer to institutional investors active in Asia’s G3 debt markets, who are suffering the second worst year of the decade for returns (after 2011). At the end of November, the Bloomberg Asian High Yield Index stood 349bp wider than it was at the beginning of January.

And that’s the good news. Many of the Chinese property names that came to the market in January 2018 are now trading at double their issuance levels.

MUSICAL CHAIRS

Yet for intermediaries, it has been the second-best year on record – theoretically at least. Year-to-end November issuance volumes across Asia ex-Japan G3 may be down 20% compared to last year, but they are still higher than 2016 and any year before that.

But how accurately do the league tables (see table 1) reflect who has had a good or bad year in Asian debt capital markets (DCM)? Not very is the general market consensus, particularly where China and high yield is concerned.

“If the fee league tables were re-configured on a mark-to-market basis, then the rankings would be very different,” said one Singapore-based banker.

A second added: “Chinese banks and securities houses, which bought deals to trade off their own prop books, are now sitting on the same losses as institutional investors. A few of them are still playing that game but in far smaller amounts.”

What has been happening to that warehoused debt? Some bankers and traders believe that securities houses are re-packaging it for retail investors on the mainland. History has repeatedly suggested this will not have a happy ending.

Others, however, disagree.

One banker at a leading Chinese bank said that onshore regulations no longer permit offshore bonds to be re-packaged into retail-targeted products. He believes that paper is being placed among China’s smaller institutional investors and banks, which are not allowed to buy offshore debt directly.

He also reckons that securities houses will simply hold debt on their prop books until maturity.

“If the current conditions continue well into next year then some of them could burn all their bullets,” he commented. “But they currently believe they can ride it out.”

Nevertheless, there are continued reports that chunks of debt are being dumped on the secondary market. “We’re still seeing instances of panic selling hitting individual credits,” one Hong Kong-based banker remarked.

Unsurprisingly, talk of losses and tougher bond markets appear to have prompted a number of Chinese intermediaries to re-think their DCM strategy. For example, a number of Chinese securities houses, which were active earlier in the year before the markets turned south, have been notably absent from deals of late.

Dealogic data shows that Zhongtai Securities was the third most active Chinese securities house among the top 20 Chinese G3 high yield deals during the first quarter behind Haitong Securities and Guotai Junan.

It is no longer appearing in deal syndicates, although Haitong and Guotai Junan remain as prominent as ever.

Likewise, fourth-placed GF Securities has disappeared, as has seventh-placed Dongxin Securities.

Bankers also note that institutional investors are now doing as much due diligence on syndicate structures as they are on the actual credits being offered.

High yield deals from China with large syndicates populated by intermediaries likely to take paper for relationship reasons, to trade off their own book, or to distribute among friends and family investors are top of the no-buy list.

Conversely, small syndicates led by intermediaries that execute market-driven transactions may be given a hearing.

One Chinese banker hopes that the International Capital Market Association (ICMA) will do more to educate issuers and Mainland regulators about best international market practices. This may gain added traction now that China has taken steps to unify its bond market regulations under the China Securities Regulatory Commission (CSRC).

On Monday, the CSRC, People’s Bank of China (PBOC) and National Development Reform Commission (NDRC) jointly released a document which stated that the securities regulator will take responsibility for identifying illegal activity and then punishing it.

Chinese bankers say a shakeout of players in the offshore markets will be “no bad thing”.

But as one added: “There are still so many issues that need to be addressed such as secondary market trading levels, which no-one trusts because they don’t know whether company directors are propping trading levels up.”

And another banker said: “The fee league tables are nonsensical. We sometimes don’t even know what our fee is until six months after a deal is closed. Those kind of unprofessional borrowers are going to get progressively less support from market makers if they continue to behave like this.”

REASONS TO BE CHEERFUL

For the most part, bankers agree that investors have simply battened down the hatches for the rest of the year. The one and only thing which is tempting them back is extremely attractive pricing.

Issuers which are not willing to pay up are either staying away or, in the case of ICBC New York, pulling deals mid-execution.

There are, however, causes for relative optimism. New issue premiums have contracted from the 200bp level that characterized the first half of November after Evergrande overloaded the market with paper for the second year running with a $1.8 billion deal.

More highly regarded Chinese property issuers are also receiving a better reception, although again only because they are offering yields that are effectively double what they were paying at the end of last year.

“Even one month ago, the Agile’s and KWG’s of this world would never have countenanced paying 9.5% and 9.85% for two-year paper,” one banker explained. “They’ve now accepted it as the new normal.”

But the two deals have performed in the secondary market and bankers believe that investors will reward both borrowers’ sensitivity to market conditions with smoother market access in 2019.

As of December 4, Ba3/BB rated Agile Holding’s $400 million 9.5% November 2020 bond was up nearly three points. BB minus rated KWG Properties' $400 million 9.85% November 2020 bond was up just over one-and-a-half points.

High Net Worth (HNW) investors have also not completely lost faith with the better Chinese real-estate developers. Notably, 68% of KWG’s deal went to HNWs and 20% of Agile’s.

Bankers also note more active HNW bottom fishing in the secondary market, which they believe bodes well for 2019.

Issuers and investors both hope they are right.