The market for convertible bonds in China has been growing for the past few years. Chinese companies sold a record Rmb268.2 billion ($38.2 million) last year, with the country even taking the issuance crown from the US, according to MSCI.
The pace of issuance of the debt instruments that convert to equity is being maintained this year, even if the volume isn’t. The first half of the year saw 56 deals versus 126 deals for the whole of last year which has prompted some observers to warn of bubbles.
Shuncheng Zhang, associate director in Fitch Ratings’ Asia-Pacific corporates team, explains that the volume of convertible bond issuance has declined 40% year-on-year to Rmb92 billion. But if you drill into the figures, you see that the drop comes from a smaller issuance from financial institutions.
“If we only take into account issuance from non-financial institutions, that figure is up 26% year-on-year,” he said.
There is no doubt that investors want to buy them.
“We see there is a strong demand for convertible bonds,” confirmed Yulia Wan, senior analyst at Moody's Investors Service in an interview with FinanceAsia.
Onshore funding costs in China dropped in the wake of supportive measures by the government to counter the effects of the Covid-19 pandemic. With declining coupons, investors have had to look elsewhere for returns.
“The driver, quite simply, is the hunt for investment returns in a low interest rate environment,” Wan confirmed.
Investors are also, or should also, be protected by the structure of the bonds. Should the share price decline, then the investor can simply hold on to the bond until maturity.
There is an advantage too for the issuer.
Wan – who specialises in financial institutions – explains that issuance from smaller banks, for example, is being boosted by their need to increase capital and the benefit of these bonds to supplement capital. Conversion price reset features increase the probability that these bonds will eventually convert to equity in China.
“The overall capitalisation of Chinese banks has weakened this year because of the faster growth of risk-weighted assets and also weaker profitability,” she said.
As for the corporate market, Fitch’s Zhang pointed out in a telephone interview with FinanceAsia that some issuers might have missed the funding opportunities in the first quarter.
“If [these companies] just issue ordinary corporate bonds, they may not be able to get as cheap funding as before. Instead, they can issue convertible bonds which usually carry a much lower coupon than corporate bonds,” he said.
LOWER RATED ISSUERS
This dynamic has attracted lower graded issuers to come to market. According to Bloomberg, getting on for 90% of the issuers so far this year are rated AA or lower. Unsurprisingly, there are hints that there might be problems with some of these issuers especially as you climb down the ratings ladder.
There have been wide reports of difficulties at chemical manufacturer Jiangsu Huifeng Bio Agriculture. Following a couple of years of losses it warned, at the end of April, that it might struggle with its convertible bonds due 2022 should investors not convert the bonds into equity.
And when electronic component manufacturer TKD Science & Technology, around the same time, warned of a heavily discounted share repurchase, its 2023 convertible bond slipped 12%, though it has recovered since.
A default is yet to happen, but there have been signs of restructuring.
At the end of last week, 3 July, Chinese property development company Suncity Group Holdings pushed out the maturity date on its convertible bonds by two years from 28 August this year, to 2022.
The Hong Kong-listed company had used the HK$297 million ($38.3 million) zero-coupon two-year bond to acquire a 34% stake in a casino in Vietnam in 2018.
“Full or partial conversion of the convertible bonds on 28 August 2020 in the absence of the of the extension will end up with less than 25% of the company’s issued share capital being held by the public,” the company said in a statement, adding that the extension would also allow Suncity to have more financial flexibility in the deployment of its working capital for its business operations and development.
There is no sign, however, that the issuance of convertible bonds is likely to slow down. One reason regularly given for their popularity has been the simplicity of regulation. “The approval process for the issuance of a convertible bond is faster in China compared with some other means like private placements or secondary offerings,” said Wan.
Not that this is without concerns. Earlier this week, the Shanghai Stock Exchange started to solicit feedback on new rules for the issuance of convertible bonds by listed companies, specifically those where the funds are earmarked for M&A and restructuring.
These so-called “targeted convertible bonds” will now only be available to sophisticated investors.
As Fitch’s Zhang points out, “the aim of all these policy moves is to make this market closer to the bond markets in developed markets”.
Issuance for the rest of the year is likely to hold up, indeed some blockbuster deals are expected. Shanghai-listed and Shanxi-based Daqin Railway, for example, has said that it intends to raise as much as Rmb32 billion (US$4.5bn) from a six-year issue which will fund the acquisition of assets from CR Taiyuan.
The signs of bubbles may be overblown, but as always for investors, it is a case of buyer beware.