On Tuesday, Standard & PoorÆs downgraded Ocean Grand Holdings (OGH) some 11 notches to single-D from single-B following an announcement that the Hong Kong Securities and Futures Commission (HKSFC) is investigating OGH after apparent accounting irregularities came to light. In its report, S&PÆs credit analyst Bei Fu stated that, ôgiven a deterioration in the groupÆs cash position, OGH does not have the sufficient cash to repay short-term debt past due."
The downgrade to junk status effectively defines OGH's position as default and caused its deal to all but collapse in secondary trading.
Ocean Grand, a Hong Kong-listed aluminium extrusion product maker controlled by Chief Executive Yip Kim-po, priced a debut $125 million five-year senior unsecured bond offering in mid-December of last year via ABN AMRO. That deal was further increased to $160 million after a $35 million re-tap in February.
When the original deal priced in December, it came at 99.515% on a semi-annual coupon of 9.25% to yield 9.375%, equivalent to 497.5bp over US Treasuries. Once news of the downgrade was made public, Ocean GrandÆs bonds tumbled and as of late Wednesday they were quoted at a bid/offer cash price spread of $0.10/$0.31.
Last week the bonds were trading at $0.80/$0.85, but had dropped to $0.70/$0.75 on Monday after S&P announced an initial downgrade to single-B from BB- last Thursday (July 20).
At that time, S&P downgraded and placed OGH on CreditWatch with negative implications based on early information that had emerged publicly and its inability to access management.
The Cause
The company's problems first emerged on July 11, when OGH reported that the financial controller for its subsidiary Ocean Grand Aluminium (OGA) had gone missing. Subsequently, PricewaterhouseCoopers, the companyÆs auditor, discovered potential accounting irregularities in relation to Rmb6 million in business contracts.
The audit has not yet been concluded, and the full impact of the accounting problems is not yet known. However, OGH has stated that the problem is more severe than initially projected and also implicates five additional subsidiaries; Hing Yip Holdings, Kenlap Chemicals, Kenlap Fine Chemical Technology, Kenlap PGC Manufacturer and OG Aluminium.
On Monday (July 24), OGH announced that it had appointed Deloitte Touche Tohmatsu as a provisional liquidator to safeguard its assets while the company was placed under investigation by HKSFC's Commission for alleged accounting irregularities. Deloitte & Touche Forensic Services has been hired to investigate all of the groupÆs accounts.
This decision followed an admission on the part of OGH that due to a deterioration in its cash balance position it could not repay its short-term debts. In March, OGH reported an aggregate cash balance of Rmb880 million, but as of last week that position had fallen to Rmb40 million.
On July 17, the Hong Kong stock exchange halted trading in the company's shares pending the outcome of the investigation. Prior to the suspension, the shares had been trading at around the HK$1 level.
Following the full identification of the problems, OGH, via Deloitte Touche Tohmatus, will meet with creditors and bondholders to discuss any potential debt restructuring or repayment agreement.
However, according to bankers familiar with the dollar-denominated debt deal, a restructuring is unlikely as a white knight would be required to come in and buy out the companies, which at this time doesn't seem likely. Most agree that bondholders are likely to recoup only the nominal amount that the bonds are worth.
When the $125 million deal was first sold into the market, a total of 31 accounts were allocated paper, accounts that consisted of books from Singapore, Europe, Hong Kong and off-shore US.
Based on current market pricing of $0.10 to the dollar, a mean average allocation of around $5 million including the new $35 million tap, investors face a potential real loss of $4.5 million each.
No doubt the collapse of the deal may raise questions as to whether or not ABN AMRO undertook an acceptable level of due diligence before launching the bond deal. A spokesperson for ABN AMRO declined to comment prior to the outcome of the HKSFC investigation.
The Effect
You can excuse AsiaÆs high-yield debt market for feeling a little bi-polar this week. On Wednesday morning, Deutsche Bank, Citigroup and JPMorgan priced one of this year's most successful non-investment grade deals when they closed off a $750 million tap for the Republic of the Philippines.
So successful and so highly sought after was the deal that the 10-year tranche closed at $5.7 billion û 19-times oversubscribed, while the book for the 25-year tranche closed at $6.5 billion - 15-times oversubscribed; a total book order of over $12 billion.
Regional investment bankers had been looking to the Philippines, one of AsiaÆs largest and most astute borrowers, as a harbinger of good fortune for the debt markets; Specifically for the sub-investment grade space, where it was seen as the most likely candidate to re-open the markets after months of paucity.
As yet that may still be the case. Indonesia, which has approximately $2 billion in financing needs yet to fulfill this year, will no doubt look upon the overwhelming success of the Philippines and try to tap a market that appears very thirsty for emerging market debt.
Unfortunately, that goodwill may not flow further down the ratings ladder. The Philippines is rated B1/BB-/BB, but as a sovereign borrower is much more attractive to investors than stand-alone corporate borrowers, such as OGH.
ôWhether or not this will have a long lasting impact on the corporate high-yield space remains to be seen, but I donÆt think you would view this as a positive in terms of investor sentiment,ö says one investor. ôThere will be a lot of questions asked about the due diligence here, and I would believe that in the short-term, at least, you have seen the end to these types of smaller companies coming to market via sole-led deals.ö
When OGH first came to market, it rode in on the back of a very bullish wave in the high-yield corporate space. Sentiment was strong, and investors and borrowers alike were generally contented with the fundamentals of the sector. However, there was an underlying scepticism among investment bankers that spreads were too cheap and credits that didnÆt have strong enough economics were being brought to market û heightening the chances of default in times of uncertainty.
Earlier this year, when concerns over the future of US interest rate hikes and overall market volatility pushed out spreads globally, and in emerging markets specifically, some had hoped that the market had managed to tighten issuance flow, and ensure that the deals that were coming to market would be sound enough to ride out any market mishap.
Now, with the first default looking all but academic, the question that remains is just how much of an impact it will have on an already struggling high-yield debt market.
Although the longer-term consequences are far from clear, the immediate implications are numerous.
Ocean Grand's bonds were primarily owned by investors who were relatively new to the emerging market high-yield sector, while the larger institutional accounts have already moved out of the market because of recent volatility. This is particularly true in the case of the public banks which are naturally more cautious investors. It will likely be these newer accounts and the retail investor that will be hurt most by this deal, as the real credit players by and large gave a miss on this bonds in the first place or played relatively small positions.
ôOcean GrandÆs default is only going to reinforce the view among the bigger EM high-yield investors that they will only buy deals from credits they really like and they will only buy them if they can get what they believe to be acceptable levels,ö says one syndicate banker.
Indeed, going forward investors will be much more adamant about the due diligence and coverage of deals that come out of the Chinese high-yield space and the smaller corporates in particular.
ôWhereas we had hoped that China would be a leader in terms of issuance in the high-yield space, I think now Chinese sub-investment grade deals will be handicapped,ö says one banker. ôAdditionally, even though Ocean Grand was listed, the smaller private companies are going to find the market a lot more difficult to access now. Investors are going to want to have absolute transparency. Structural strengths and weaknesses will now come to the forefront and investors will approach any potential issues with a 'prove it works' attitude. Proper use of proceeds and utilisation of cash are going to be key.ö
Undeniably, the trust factor is going to be paramount. Potential issuers who have a poor reputation or track record within the market for any reason are going to be at a huge disadvantage.
It will be left up to the regionÆs investment banks to provide that level of trust. Any bank looking to bring these deals to the market will have to screen much more actively in preliminary stages and the provision of ongoing research coverage is going to be principle for investors.
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