Asian high yield: the only way is up? Part two

Asia’s high yield markets were on fire during the first quarter of 2017 — and much of that was down to Greater China.

The second quarter is shaping up to be a little different as Chinese issuance shows signs of tailing off and foreign investors hold back. Is this an omen that Asia’s high yield markets are turning?

In part two of our series on the sector, FinanceAsia examines what recent issuance trends may be saying about the high yield market’s performance over the rest of the year.

During the first quarter, Chinese and Hong Kong non-investment grade borrowers accounted for 87.5% of the $23.6 billion raised across Asia ex-Japan ex-Australia, according to Dealogic figures.

The biggest chunk of that fundraising came from the Chinese real estate sector. This accounted for $9.16 billion, or 44% of the Chinese total and 38.8% of the region’s overall issuance volume based on Dealogic’s broadest measure of non-investment grade credits, which includes issuers that do not incorporate standard high yield covenants such as Noble Group and Beijing Properties.

Derek Armstrong, head of the Asia debt finance group at Credit Suisse, told FinanceAsia the Chinese real estate sector provides a good leading indicator for the broader market. “When Chinese real-estate is strong then it generally tells you the overall market is too,” he said.

In April, Greater China issuance totaled $3.3 billion, or 60% of the $5.5 billion executed over the course of the month. However, Chinese real estate credits have increased their overall share to 49.2% of the Chinese total at a time when the market is showing signs of indigestion.

In the same month, Deutsche Bank’s fixed income research team cautioned offshore investors to pay more heed to credit differentials given the state of the onshore market, which has been shut for most of the year as domestic rates shift higher and the Chinese government emphasises deleveraging over growth.

And non-Chinese investors, at the very least, appear to be taking heed. In its most recent EM Client Survey, published on April 21, JPMorgan’s fixed income research team noted that clients were moving underweight in emerging market corporates following a bout of profit taking.

It further highlighted that one the biggest reductions involves China. The country recorded a month-on-month drop of 0.6 points to minus two on the bank’s scale. By contrast, there was a 0.22 point overall reduction for emerging market corporates to minus 0.69.

Consequently, some — although certainly not all — recent Chinese deals have traded down in the secondary market, unlike during the first quarter when both the primary and secondary markets were unequivocally strong.

For example, Caa1/B- rated Jingrui Holding’s $400 million 7.75% deal has traded down half a point since its launch on April 5. More recently, a $300 million 6.95% deal for B-/B/B2 rated Yida China has traded down almost two points since its launch on April 11.

However, as S&P Global Ratings recently noted, the China bid remains strong in the offshore bond market, particularly from money managers re-cycling entrusted dollar deposits from savers keen to hedge devaluation risk.

As a result, "funding costs (and spreads) have declined while credit ratios are weak and show little improvement," the agency said. It concluded that any "reversal of the liquidity flow could quickly turn the feast into famine for issuers and investors."

Southeast Asia resurgent

In China’s place, there has been a clear boost in issuance from around the rest of the region, especially Indonesia and commodity-related borrowers in general. 

Indonesian issuers accounted for $1.1 billion of first quarter issuance. During April alone, they raised the same amount again ($1.13 billion) from three transactions, of which double-B rated Saka Energi’s $625 million issue was particularly noteworthy from a size perspective.

Likewise, Asia’s commodity-related borrowers raised $2.44 billion during April, accounting for 55.8% of all issuance. The sector’s return to favour represents one of the major themes of 2017, although the smart money was probably made in 2016 when credits like India’s JSW Steel were trading at distressed levels.

In January 2016, for example, the group’s 4.75% January 2019 bond was quoted at 66 cents on the dollar. Today it is back above par again and the Ba3/BB rated group successfully returned to the primary market with a $500 million five-year deal in early April.

“Investors feel confident putting their money back into new issues and are positioning themselves to take advantage of the next leg up in the commodities cycle,” Armstrong commented. “As for commodity-related issuers, many of them never thought they had market access until a few months ago.”

A perfect example of this process in action was Indika Energy’s $265 million five-year deal at the beginning of April. One year ago, its outstanding 6.375% 2023 deal was trading at only 33 cents on the dollar.

But thanks to its new Caa1/CCC rated transaction, the group has been able to improve its liquidity position and secure a ratings upgrade to B-/B2.

So far, the bonds have not really performed and continue to be quoted around their re-offer price. But many market participants believe Indonesia will finally secure its long-coveted investment grade rating from Standard & Poor’s during the second quarter, which should have a positive flow-through effect down the credit curve.

Bankers also say borrowers are becoming far more careful about hedging their foreign currency exposure. The Indonesian government forced companies to adopt a more sensible stance in 2015, when the rupiah was weakening.

Bankers say Chinese borrowers have also become more conscious of the risks since the renminbi started falling against the dollar.  

Armstrong says hedging costs have become more appealing on a dollar-hedged basis, with issuers also adopting more creative structures including caps and floors (options which limit exchange rate risk to a set band). Julien Begasse De Dhaem, Morgan Stanley’s head of Asia Pacific fixed income capital markets, agrees.

“We’re now having hedging dialogue with every Chinese borrower that comes to market,” he said. “It’s probably translating into a conversion rate of about 60% to 70%, with private sector issuers taking the lead. Two years ago, that figure would have been more like 25%.”

Bankers also notice investors taking more care. They believe some of the most aggressively structured first quarter deals, such as Road King’s fixed-for-life perpetual, could no longer get done. “Investors are definitely becoming more disciplined with primary market deals,” Begasse added.

US rate risk

That said, Begasse and Armstrong believe markets should remain calm in the run up to a potential US interest rate hike in June. Begasse believes the next hike is already priced in.

“If you look at previous interest rate cycles over 1999/2000 and 2004/2006, the emerging markets tend to perform well during the early part of the cycle.” he stated. “There’ll only be a problem if there is a structural adjustment upwards rather than a gradual increase.”

Both bankers point to a growing issuance pipeline stretching into the third and fourth quarters, although Armstrong says a number of issuers are positioning themselves to access the market before two potential rate hikes in September and December.

He highlights that many of the previous 2012/13 deals are coming up for re-financing (see table 1), while borrowers continue to assess liability management exercises to take advantage of low rates.

Table 1: Asia ex-Japan, ex-Australia issuance volumes non-investment grade debt

Source: Dealogic

Begasse calculates that Asia’s net new issuance volume has only been about one third of the total, reinforcing arguments that issuance momentum should continue in tandem with Asia’s emergence from a multi-year earnings recession. 

Asia also remains relatively well positioned compared to the US high yield market, where maturities are much longer — exposing investors to duration risk in the event of rising rates.

As Begasse concluded, “The issuance window has been wide open and the market has been incredibly receptive. As we always say to issuers, take advantage of it while you can.”