Roundtable: Chinese high yield issuers prove resilient

The first half of 2020 will always be defined by the Covid-19 pandemic, a moment of history during which the world changed dramatically. That change was most noticeable in social interaction, and in how people worked, but the pandemic inevitably had an impact on the bond market. Chinese high yield borrowers seemed to be nearly shut out of the dollar bond market in March and April, as investors looked for safer investments. But things slowly started to return to form ─ and by June, deal volume was back with a vengeance.

Funding officials at Chinese real estate companies told GlobalCapital during our last roundtable in April that they were optimistic things could return. They were proved right. The market is not just open; it is open at increasingly attractive borrowing costs. But there are plenty of questions facing nervous borrowers at the moment.

How long will the market remain open? Are defaults still a worry for investors? Has the Covid-19 coronavirus increased the need for transparency from issuers? GlobalCapital sat down with a panel of senior market participants to find out.

The participants were:

Kenny Chan, chief financial officer, Zhenro Properties Group

Adrian Cheng, senior director, Asia Pacific corporates, Fitch Ratings

Simon Cooke, portfolio manager, emerging markets, Insight Investment

Eugene Fung, senior portfolio manager, head of credit and equities, BFAM Partners

Lawrence Leung, head of capital markets and investor relations, Cifi Holdings (Group) Co

Gerhard Radtke, partner, Davis Polk & Wardwell

Fredric Teng, head of high yield, capital markets, Greater China and North Asia, Standard Chartered

Moderator: Morgan Davis, bond editor, GlobalCapital Asia

GlobalCapital: We are in a very different position than we were during our first roundtable in April. The high yield market seems to have recovered and volume is up. What has changed?

Eugene Fung, BFAM Partners: The recovery has certainly continued. The biggest sector, China property, is now at the stage where most names are back to where they were probably pre-Covid outbreak. And people in general have access to capital markets in a very easy and normal way. Their biggest hurdle, which was NDRC [National Development and Reform Commission of China] approvals, seems to be a lot more normal as well. People are able to get the quota they need to issue bonds. And people are pretty comfortable doing it. We’re seeing a lot of deals now. The good thing is that a lot of these issuers are issuing new bonds while tendering for old bonds. And that new issuance is not that big, so the market is very easily absorbing it. We’ve seen guys get more aggressive as far as pricing through the secondary just to get better price and execution for themselves, which is a sign that the market has normalized to a point where it has flipped in favour of the issuer again.

Fredric Teng, Standard Chartered: It’s a function of which credits benefit first in an improving environment from a liquidity standpoint. If I think back a couple of months ago, the lower beta names sold off less and fast forward to now it’s the names that led the initial rally.

Country Garden’s January 2030 bond before the crisis was trading around 101-102 and then it started dropping down to around 90 cents. Over the course of the recovery these bonds went up to now, they’re trading around 104, 105. They’re higher than pre-crisis. This is exactly what we’re seeing now: people pricing deals tighter.

Then you have the double B names. They sold off as well down to the 80s, depending on the maturity. And then they bounced back slower than Country Garden, but they bounced all the way back. A Cifi July 2025 bond that was priced in January dropped down to the mid-70s from par, and right now this bond is trading at 101. So again, higher than the beginning of the year.

Then you go down the credit curve a bit more to our friends at Zhenro Properties, which are rated B+. They have a 2024 bond currently trading at 99; they were at par and went down to 72 or 73. So once you get to the single B category it is almost flat to the beginning of the year.

Within those names, there are specific technicals. Some were downgraded or have negative stories, so their performance may be better or worse. From a credit profile perspective, the higher rated names have outperformed on the recovery.

GlobalCapital: In March, we saw rating actions across the board in Asia. How does Fitch feel about the high yield China sector now?

Adrian Cheng, Fitch Ratings: We’ve done quite a few negative rating actions on the lower-rated homebuilders, mainly on refinancing risk and liquidity issues. The risk is still there, where they struggle to generate sales and they don’t have enough access to the offshore market. They may have access to the onshore market but their ability to pump that cash offshore is limited and it takes time. The risk to refinance offshore maturities is something to be very careful of.

Over the past few months when we downgraded these companies, we were at a stage where it was very apparent they were running into refinancing risk. At this point, the companies that we think should have been downgraded have been downgraded already. We don’t foresee mass downgrades in this sector unless there is a fundamental change in the industry for the worst.

It’s a bit early to talk about upgrades. We upgraded a state-owned enterprise but that was not because of its performance, but a higher likelihood of government support. There are a few things we need to be mindful of in terms of an upgrade. One thing is the homebuilders’ ability to generate sales and sustain the sales at a certain scale while maintaining the relatively conservative credit metrics and policies. And at the same time, they plan to refinance well in advance. In those cases, if that can be sustained, especially on the sales front, then I think there will be some room for upgrades for some companies.

GlobalCapital: How have investors responded to these changes in Chinese high yield bonds?

Simon Cooke, Insight Investment: Back in April we saw a once in a decade opportunity as a fundamental value investor to generate very healthy returns, double digit returns, over the coming 12 months. And we’ve already seen that happen. We did not expect it to happen so quickly. Things like the default rates that we were expecting back in April probably won’t be as severe now. We weren’t expecting massive defaults, but it has eased since then because some issuers that would have been at risk have found ways to source capital because of the global support from central banks and governments. That’s the biggest change that caused a massive rally. Governments are doing all they can to support individuals, companies and economies. 

Because of that, you’ve seen issuers take advantage of the market recovery and you’ve seen healthy supply from China high yield, particularly in June and July, and that’s something back in April that you wouldn’t have expected. It means there are issuers we already liked who had prefunded 2020 in the first quarter, who have now prefunded 2021 too. So you’ve got issuers in an even a stronger position, liquidity wise, than they were in April.

We’ve also seen that China high yield still seems to be relatively resilient. It was one of the first risk assets to come back and it has had one of the smallest drawdowns. If I look year to date in emerging markets, China is the third or fourth best performing high yield market. It’s come back very quickly and it’s stayed there. When you look at the last couple of weeks with the US and China geopolitical tensions, it’s noticeable that China high yield has not followed the equity markets. It seems like it is resilient, at least in the short term.

What we’ve seen over the last month or so is that single B credits continue to stand out on a relative value basis versus the rest of emerging markets. B rated Chinese property still looks very attractive. BB still has a slight premium, but not as much as there was back in April. Industrials? We’ve not liked them for years. We didn’t like them in April and we definitely don’t like them now. For us the sweet spot is the single B China property space and we think there’s likely more support in the slightly shorter end. You have seen some of the slightly longer bonds have not performed as well recently as the shorter dated stuff.

GlobalCapital: How has China’s high yield market held up compared to other countries in Asia? Have we seen recovery anywhere else?

Fung, BFAM Partners: The great thing about China is that it’s a big enough country that they have a lot of bullets to support the overall economy and you won’t see a large amount of defaults. In Indonesia or India, they don’t have the same amount of fire power to prop up the market. The last time we talked, a lot of Indonesia names were in the 90s and 80s and now they’re in the 20s and 30s and 40s – especially the property sector, which in China is so resilient. That seems to be the weakest part of the Indonesia high yield market.

We favor commodity names now at a discount, in the 50s to 70s, in Indonesia over owning property names in the 30s and 40s. We think those Indonesia property names will really have to go through a restructuring just because the government doesn’t have the time of bullets to really support them.

GlobalCapital: Zhenro has been in the dollar bond market a couple of times since we last spoke in April. Why did your company decide to sell dollar bonds? How did investors respond?

Kenny Chan, Zhenro Properties: We did a dollar bond because, to a certain extent, we could print a longer-dated bond. In China, they’re only looking at two years or three years, but in the dollar market we could print more than four or five years, if the price is OK. If you look at the situation in May, we printed our bond at around an 8% handle, which is not a big difference from the domestic market. Maybe a 1% or 2% difference. When Covid-19 was happening in March, no company could price a bond at that moment. I’m very happy to see that many of our peers voluntarily disclosed their situations and they kept investors and rating agencies well informed of their situations after that. In May, after investors had two months of observation, they felt comfortable with the market. In May, I could feel that the ticket sizes were relatively smaller than before, but the number of investors is similar compared to the old days.

When I priced my second bond in June, I could feel that the momentum was already back. Up to now, some of the key institutional investors may not be very keen to participate because they have concerns about pricing. It’s too expensive to a certain extent. But overall, investors don’t have any concerns about the Covid-19. You can see the property contracted sales announcements since May. If you look at the past four weeks, quite a few issuers priced inside of their curve. They didn’t pay any premium at all. In the last two months, the market price has been back to an equilibrium, but there are some bonds in secondary that are still not reflecting their true price yet. So some developers can price inside of their curve.

Some of the issuers were quite aggressive, so we have had some strong pushback from investors, and that’s when you see the order book drop almost 50%-60% after tightening. These days I think that we may have to pay premium again, but I don’t know how much the premium will be yet. 

GlobalCapital: What kinds of bonds are investors looking for?

Lawrence Leung, Cifi Holdings: My personal view is that investors are tenor sensitive, but they are more sensitive on the quality of the issuer, the potential supply of that particular issuer and how the transactions are being managed.

The bonds of the better names or more financially-disciplined names tend to outperform. I don’t want to name specific names, but if you flip through the recent transactions, some of the names, including our own, are doing well in the aftermarket. Investors are supportive and constructive. But there are one or two transactions that were not executed that well and the bonds are still way below water. For single B credits, investors are more tenor sensitive, and on double B it’s more the quality of the issuer and how the transaction is being managed.

It’s about the fundamentals of the issuer and the communication with investors, whether the transparency and the information are up to their satisfaction. And also, when we price a transaction, it is about whether it is priced at the right level and allocated to a good combination of investors. All of these things together determine the after-market performance of the bonds.

GlobalCapital: Cifi also sold a bond recently, the company’s first green bond. Why did you decide to sell a green bond this year? Did it make a difference in the pricing of the transaction? Leung, Cifi Holdings: We always put a very high emphasis on sustainable development. As you know, it’s become a big trend and we collected a lot of feedback from our stakeholders that environmental, social and governance (ESG) related matters are becoming more significant. Last year we established an ESG committee. Going forward we want to establish this green bond framework as one of our key financing channels. Obviously, we have to make sure the bond proceeds go into green projects as well, under our green bond framework. So at the same time, management has been raising the green standards in our projects.

Our understanding is that European investors in general are more advanced in green bond investing, so they have more systematic evaluations. When we talk with them, they have a systematic approach to evaluating the green elements of the bonds. The Asian investors also have increasing attention on ESG standards of their invested companies. For this round of the bond issue, we gathered support from our long-term investors, but we also gathered interest from some of the green focused investors.

At the initial stage, the price benefit is not really that significant. As we continue to drive this green initiative, it’s not just the financing initiative, it’s the company as a whole taking up social responsibility. We have to incorporate the green elements into our business, including various aspects to implement energy saving and use environmentally friendly materials. All of these things together will be a new driver for our business. By cultivating these green financing channels to establish relationships with green investors, we do believe that eventually we will get an edge on the funding costs.

Teng, Standard Chartered: Traditionally, European investors have been at the forefront of green investing, but we also know that from an investing perspective, in terms of their scope, investment grade pretty much dominates what they can buy. This BB benchmark transaction from Cifi is significant in that we created a credit spectrum where there is a green premium created. The number of European investors that invested with Cifi at new issue is 33%. That’s a big enough chunk to provide some pricing elasticity on the final outcome. If a green investor or European investor is only 5% of the final deal, we will then price at whatever price is dictated by the majority. But 33% is not a small minority. There’s a lot of work to be done to invest in green bonds and I think people are willing to pay a bit more to invest in this aspect that is important to them. But to try to tighten 20bp-30bp more? I don’t think we see that.

One thing I did take away from the marketing process for the Cifi bond was that there was a fair bit of concern from investors around whether this was a genuine green bond, because for the longest time this area has been more about marketing. There is genuine investor concern that when they are buying into a green bond that the institution itself has a culture around ESG and green.

GlobalCapital: Has Zhenro considered issuing a green bond as well? What kind of interest are you finding from investors?

Chan, Zhenro Properties: Investors, especially large-scale institutional investors, are now looking at the ESG performance of our peers. This may be because of the new regulatory requirements. In Hong Kong, we are required to release ESG reports every year, but I have a feeling that investors are getting more concerned about ESG because of the current Covid-19 situation. When investors talk to us, they ask for our ESG report.

I think we will focus more on ESG. We are actively considering disclosing our green bond framework in our upcoming offering circular, but we may not want to call our bond a green bond because once we call it a green bond, we have to consistently call it a green bond. If one time we don’t call this bond green, investors will question if we’re going green or not. We’re handling this demand but we’re cautious.

Green bonds are not a new topic in the China bond market. We are required to fulfil local green requirements for our commercial buildings, or we cannot obtain a building certificate. But from the investor perspective we are not very sure.

We have hundreds of investors. Right now, no single investor will say that if we do not do a green bond they will not buy our bonds. But if we could do a green bond, maybe they could also enlarge their ticket size. Some of the institutional investors have their own green funds. With a green bond label, they may be able to give me a bigger order size, but in normal market sentiment like these days, the order book is already very oversubscribed. So even if they give a bigger order, we cannot protect their allocation. Green bonds, at this moment, are more a marketing strategy.

GlobalCapital: We’ve talked a bit about how transparent Chinese property borrowers have been with investors since the outbreak of Covid. What are your experiences with this?

Cooke, Insight Investment: The level of communication and transparency is very good, particularly from the Hong Kong-listed companies. They were very proactive in having calls with investors. There’s a very healthy level of dialogue, and they’re very transparent in terms of what they’re seeing on the ground in terms of liquidity, which gives investors the reassurance of what was actually happening day to day.

The pandemic’s impact was very short-lived thus far and it’s been a V-shaped recovery. July sales beat expectations and should reinforce investors’ confidence in the full year sales earnings, and similarly we expect the first half results to see solid top line, flat to slightly low margins. The recovery has been quick. We have confidence in the management teams because of their transparency and how they’re managing their balance sheets.

It’s also worth flagging that issuers that were coming to issue through June almost entirely didn’t need to come. It wasn’t like there were loads of issuers that were going to go bust. Issuers were instead saying: “The market is open, there’s still liquidity available, let’s take advantage of what is actually attractive pricing compared to some periods in history. Let’s lock in the yields now. Let’s get the liquidity now so we don’t have to worry about it in six months’ time.” That’s a different investment case for us versus an issuer who is begging, “Please give me the money now or I’m going to default in a month or two.”

GlobalCapital: Fitch has recently started rating bonds that have sub-one year tenors, something it had not done before. Why the change?

Cheng, Fitch Ratings: The answer is very simple — we’ve been asked to rate the bonds. It’s a decision from the company, probably to see if they can get cheaper pricing. These bonds can help in terms of immediate refinancing pressure. But we look at refinancing risk and capital markets debt that is due within one year. So the question of refinancing risk will come back again in about six months.

The positive thing I can say about the 364-day bonds, from a refinancing perspective, is that you do not need NDRC approval. As long as the market is OK and the pricing makes sense, there is more flexibility to refinance the 364-day bond with another 364-day bond.

GlobalCapital: There have, of course, been some notable defaults in China high yield this year. Peking Founder Group certainly made waves with its default. Has that impacted the wider market?

Cooke, Insight Investment: The big interesting default for everyone is still Peking Founder Group because of the keepwell. Keepwell structures are a red flag and always have been. They don’t prohibit us from investing, but there is a question of why an issuer goes with a keepwell rather than going the guarantee route. It should be a red flag for investors that someone wants to do this quickly without the full process, and therefore we need to do a deeper dive. It’s one of those things where we could never understand how people could lend to them. There was a veneer of it being strategically important and owned by a prestigious university, but the reality was anything but that.

I think what Founder Group has done is hopefully alerted the broader market to issues with keepwells. They are only about 10%-20% of China’s market now, where a few years ago they were much more significant. Depending on the outcome of the court case, issuers should respond accordingly. If the court case finds that keepwells are enforceable and that keepwells don’t rank behind others in the capital structures, then fine. Given there just isn’t a legal precedent at present, we need to be cautious about it.

Aside from that, what we’ve seen is that the default forecast has improved slightly from what was being forecast in March. We expect the defaults to be driven by China industrials, and some Indian and Indonesian names. If you’re looking at China high yield, industrials are the real risky area.

The names that are at risk in China property are names that, for a long time, had issues and well-flagged problems, that are cross-defaulting or that are very small. The blue chip China property names can continue to trade resiliently because they are resilient and not tainted by idiosyncratic problems in the sector.

China industrials are harder. If I look at valuations, something like 15%-20% of China industrials are trading below 80, compared to about 3% of China property. The industrials we haven’t liked for years, with weak business models and thin operating margins, are really starting to suffer.

GlobalCapital: Do the other panellists share this scepticism of Chinese industrials?

Fung, BFAM Partners: It’s on a very name-by-name basis. There’s an oil services company that defaulted that used to trade at a 7% yield and in January could have exchanged all its bonds. I think they wanted to get a better print than what it was in January, and what happened was that they weren’t able to agree to a distressed exchanged and they defaulted. That’s unfortunate because it was actually a good company, and now they have to go through a hard default and a restructuring. But it shows that if people are a little bit picky, they can fall through the cracks.

Defaults are happening all the time. It’s whether we see a really broadscale of defaults. On the industrial side, or any sector that doesn’t necessarily have implicit government support, it really depends on the name. There will be defaults, but depending on the name there may be more foreign investors in it and it may be highlighted a bit more versus it being more locally driven. But if you look at the number of defaults in China high yield in the last six months, it has been happening, it just hasn’t really stopped the rest of the market from functioning normally. And I would tell you that in the default that I mentioned earlier in oil servicing, that default had zero impact on its most direct comps and their bond prices. It shows you that everything is pretty name dependent.

Gerhard Radtke, Davis Polk & Wardwell: We have seen in the industrial space issuers who have tried to complete exchange offers and those did not go through. One of the examples is Hilong, which is now working with a creditor group in a more structured environment. That illustrates how, for that particular issuer, the Covid situation, the general uncertainty and the turmoil in the oil market really combined to hurt an issuer that otherwise is better positioned to keep its business running and maintain profitability. But due to the timing of the maturity of one of its offshore bonds, it really ran into a wall. That is very unfortunate. One would have thought that a capital markets-based solution would have worked, but ultimately the necessary investor groups didn’t come together. At the beginning, it probably didn’t appear to the investor base that this was a very serious situation.

There is certainly a differentiation between the stronger real estate issuers and the weaker issuers. The stronger issuers have been able to obtain good-sized deals and have been able to price at coupon levels that are historically quite attractive. Some of the weaker names are getting into real distressed situations. Some of them have missed interest payments onshore. It’s only a question of time before offshore bond holders of those names take action.

GlobalCapital: What is next? Will the supply from high yield China continue for the rest of the year?

Radtke, Davis Polk & Wardwell: There are certainly still some names that may be perceived to be niche players or highly-leveraged that may find it difficult to arrange for a refinancing. Then it’s really a question of whether those issuers are nimble enough to monetise assets to address the upcoming maturities.

Onshore, we have seen a couple who haven’t met their onshore bond [payments] and I think there may be a couple more names. But it is a big pond of issuers so it isn’t really that surprising that in a year that has seen so much uncertainty and so many different pressure points that there would be some that would struggle. Yes, investors do need to look at the issuers specifically. They shouldn’t blindly buy a sector. It is, after all, a high yield market.

What I do hope is that in the third quarter the market will open to industrial names and more debut names. We’ve certainly been working on those types of deals that were initially slated for Q1. There’s a realistic expectation that in Q3, we could see some of these names come forward and be able to complete transactions.

Teng, Standard Chartered: I think we are more than half done now for the quarter, as far as supply is concerned.  Companies that need to refinance in Q3 have front-loaded. We’re a third of the way through the quarter but we’re probably half done. In August, there will be a brief period of inactivity when companies go through their blackout period. Generally, this time of the year there are fewer deals. With half year interim result announcements, it will be interesting to see what some of the industry leaders in the sector will say about their future outlook. The messaging will be important and the market will spend more time focusing on that.

When we go into September, I think there will be some deals done, subject to market conditions. Then comes the US presidential election, where everyone is expecting it to be more volatile in the market. It’s been incredible how this market has been resilient. Covid-19 aside, there is geopolitical tension between the US and China. But so far the market has been able to take it in its stride. That said, the risk has always been on the back of issuers’ minds.