High-yield issuers must pay up as risks increase

Investors are demanding higher compensation due to the potential rise in Asian corporate defaults, mounting geopolitical risks and a China slowdown.

Looming corporate defaults, escalating geopolitical risks and a slowdown in China’s economy is leading to a rise in the cost of financing for high-yield borrowers, prompting investors to exercise caution and demand higher compensation.

The trailing 12-month high-yield default rate for Asia-Pacific corporates as of end-July was 4.1%, up from 2.2% at end-2013, according to a recent Moody’s report. The default rate for the sector is expected to peak at 4.3% in September.

The rise in the default rate reflects the slowing of the Chinese economy as it rebalances and credit stays tight, the rating agency added. Also, Asean economies, particularly those that are commodity reliant, are vulnerable to the growth correction in the mainland — a major consumer of commodities or resource-related products.

At the same time, the US high-yield space fell victim to rising geopolitical risks from Russia-Ukraine and the Middle East, which triggered a minor sell-off and caused spreads to spike from 5.3% earlier this month to 6.5% last week for BB-rated names. The Asian high-yield market is not immune to this phenomenon, bankers told FinanceAsia.  

“The market is recalibrating risk — you probably have to pay a bit more now than what you were supposed to pay three months ago,” said a Singapore-based syndicate banker. “There could also be a temporary hiatus in terms of high-yield issuance because when the market gets choppy only investment-grade gets done.”

Last week, Berau Coal pulled its $450 million five-year bond offering, citing adverse market conditions. Although falling thermal coal prices and prevailing scepticism towards the company’s corporate governance practices could also have been factors, credit analysts said that investors were poorly compensated.

Berau’s bond launched at an initial price guidance of around 10.5%, but analysts felt that a return of 11% or above would’ve been sufficient to get the deal done.

“Investors are savvy enough to be discerning as to which ones to buy,” the syndicate banker added. “There is still ample liquidity out there for high-yield supply to be absorbed, especially in Asia.”

It’s true that high-yield borrowers can still execute deals but only if investors are adequately compensated. China Hongqiao, for example, sealed a $400 million three-year offering at a yield of 7.625% end-June after having aborted plans to sell US dollar bonds twice before.

The deal offers encouragement to other borrowers in similarly difficult sectors plagued by cyclical market challenges.

Looming defaults

The increase in the high-yield default rate was due to three defaults since the beginning of this year, Moody’s said.

Both Australia-based iron-ore producer Midwest Vanadium and timber firm China Forestry missed bond payments in February and June 2014 respectively, while Indonesian-based coal miner Bumi Resources failed to pay coupons on its existing convertible bond in July.

Although defaults are a risk to bondholders, credit analysts said that such defaults are likely to be contained amongst distressed credits that have specific operational or financing problems.

“Most of these names are already well-flagged in the markets,” Sandra Chow, credit analyst at CreditSights, told FinanceAsia. “Unless the credit markets or banks tighten lending significantly, we do not see a wave of defaults across the whole Asian high-yield sector.”

Asian bond markets saw strong support last week, with China real estate high-yield was rebounding by 1.5bp while China industrials improved by 1bp, according to credit analysts.

Although this is insignificant compared to the investment-grade space, where China BBB property names were about 15bp tighter last week, the high-yield sector is still able to offer returns just as long as investors remain selective.

Syndicate bankers are confident that Asia will continue to see further issuance in the high-yield space, albeit less than the investment-grade sector.

“If there are no major surprises on the macro front — with the Middle East and Russia noise, as well as US economic data and Treasury expectations — I believe the primary market will continue to ramp up in activity through September and October,” said Luke Garner, co-head of high-yield capital markets for Asia ex-Japan at JP Morgan to FinanceAsia. “Investors still favour the asset class given the relative returns and I do expect more non-property high-yield names to access the market.”

According to Dealogic data, real estate names account for more than 50% while Chinese issuers account for more than 60% of the total high-yield market in Asia ex-Japan, which currently stands at $18.5 billion year-to-date.

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