Chinese high yield bonds: pig of a year ahead

Has the G3 market reached bottom, or will continued spread pressure tip more stressed credits over the edge?
There are two ways of looking at the prospects for the Chinese high yield market in 2019. 
Optimists might point to the fact that the year of the pig is approaching. Of all the signs of the Chinese zodiac, pigs are ones most associated with luck and good fortune.
China’s offshore high yield borrowers are certainly in need of both after witnessing yields double from an average of 5% to 10% during the course of 2018. 
But there are plenty of pessimists around who would turn that expression into a pig of a year instead.
ANZ fixed income research shows that China’s universe of stressed or distressed dollar-denominated credits more than quadrupled from $15 billion at the beginning of 2018 to $63 billion by December.  
Owen Gallimore, ANZ’s Asian head of markets credit strategy and research, calculated that more than 160 bonds were yielding over 11% as the market wound down over Christmas and the New Year.
The differential between Asian high yield and investment grade credits also doubled over the course of 2018, prompting losses across the board. 
Some fixed income funds even ended up having to close after making the wrong trading call about the year’s biggest defaulter - Noble Holdings - which is still trying to restructure its $3.5 billion debt. 
The key to unlocking 2019’s performance will be how much longer the pain lasts and if it continues, whether it will tip Chinese high yield credits into a self-sustaining default cycle. 
On balance, most debt capital markets bankers err on the side of optimism, relative though that is given heavy supply forecasts. 
Conan Tam, co-head of Asia Pacific debt solutions at Bank of America Merrill Lynch, sums up the prevailing view that “geopolitics is making it very difficult for issuers across the credit spectrum to time their market entry and we don’t expect that to change.”
Yet as Sean McNelis, HSBC’s co-head of Asia Pacific debt capital markets, points out, the high yield market does appear to be stabilizing. “Issuers are accepting these higher yields as the new normal and just getting on with it,” he said. 
Derek Armstrong, head of Asia Pacific debt capital markets at Credit Suisse, believes that the market has potentially hit bottom. “Investors started adding risk in late November and private banking clients are also becoming more confident so the liquidity is there,” he remarked.
“We don’t think the Asian high yield bond market is about to suffer a major shock,” he continued. “Yes there is a risk of defaults, but we think they’ll be small and contained.”
Armstrong predicts that volatility will be similar to 2018. 
Amit Sheopuri, co-head of Asia Pacific debt capital markets at Citi, also sees investor appetite returning. “I don’t want to sugarcoat the situation since the high yield market will continue to be difficult, but there is cause for some optimism,” he predicted.
Nevertheless, bankers agree that borrowers at the lower reaches of the credit spectrum are going to find market access as tough as 2018 and will have to try their luck in the bank market. 
“Some of the weaker single B credits may have to find other sources of financing,” suggested Haitham Ghattas, head of Asia Pacific debt origination at Deutsche Bank
“However, we remain pretty optimistic,” he continued. “Borrowers that care about their capital structure, spend time with investors and price risk appropriately, will continue to maintain market access.”
JP Morgan’s fixed income research team believes that the market will be bolstered by reduced issuance from Chinese high yield property credits. It forecasts lower refinancing needs than 2018 and estimates that $19 billion will be raised over the course of the year. 
In its 2019 outlook, the team concluded that, “yield levels are similar to what we saw back in 2014 to 2015 before the opening up of the onshore bond market and the active involvement of Chinese investors.”
The US investment bank sees good entry levels and strong fundamentals, although it acknowledges that, “we could still see oversold levels in the next couple of months”.
However, while the property sector grabs all of the headlines, it is not the one which worries market participants most. That would be the Chinese high yield industrial sector.
Ernst Grabowski, head of Asia Pacific debt syndicate at Morgan Stanley, said: “It’s a potential source for concern as many of these issuers only ever came to market once at the height of the bull market.” 
He added, “They’re not well-followed by investors and there’s hardly any research about many of them.”
ANZ’s Gallimore notes that Chinese industrial credits have the highest number of bonds trading at stressed or distressed levels. 
JP Morgan quantifies this as 20% of names trading below 80 cents on the dollar. And most have maturity dates in 2019 and 2020.
They include credits such as B3 rated Jiangsu Nantong Sanjian. The construction company’s 7.8% October 2020 bonds are yielding around 25%.
And those kinds of levels do not just apply to lower rated industrial credits either. 
Even some credits teetering on the border of high yield status, such as BBB- rated Envision Energy International, have blown out. Its 7.5% April 2021 bond is currently yielding around 27.5%, for example. 
“I’m not sure the sell-off is always justified by the fundamentals,” commented Sebastian Ha, head of debt syndicate at Bank of China
“If markets settle down again, then we expect investors to start doing more credit work on some of these industrial names and issuance levels to pick up again.” 
One sector where large issuance will be a given - markets willing - is that of local government financing vehicles, more commonly known as LGFVs.
While many vehicles have investment grade ratings, investors remain concerned about underlying credit metrics, which may warrant a C rating or lower.
Investors’ lack of knowledge one way or the other has caused plenty of fear about potential defaults and the government’s willingness to bail out errant local governments. 
During 2018, spreads widened every time investors got wind of a potential issuance wave. However, it never really materialized given how many issuers were shut out of the market. 
Opinion remains divided about 2019. BAML’s Tam and ANZ’s Asian DCM head, Kang Jae Kim, both believe that issuance should be better received if the government turns back to infrastructure funding to support GDP growth. 
But Mizuho analysts take the counter view and argue that the government will be constrained by existing debt levels and will rely on corporate and household tax cuts to stimulate growth instead.
ANZ’s fixed income research team concludes that investors should adopt close monitoring on a case-by-case basis, not just of the 18 bonds currently trading at distressed levels, but also “unpredictable NDRC approvals, wider ‘whack-a-mole’ financial regulation, fundamental dollar-renminbi funding mismatches and questionable corporate governance.”
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