Asian Junk Bond Market Exposes Cracks

Credit risk rising for companies with lower credit quality as developing economies in East Asia face slower growth.

Asia’s junk bond returns are lagging behind investment-grade debt like never before as China’s weakest projected growth since 1990 and escalating leverage expose cracks across the region’s economies.

Speculative-grade notes denominated in dollars have gained 2.76 percent this year through May 9, 1.95 percentage points less than high-grade bonds, according to index data compiled by JPMorgan Chase & Co. The underperformance is the worst over the same period since at least 2005. Globally, returns were about even at 4.1 percent, Bloomberg indexes show.

Increasing indebtedness in the world’s second-largest economy and twin deficits in nations from India to Indonesia mean twice as many Asian companies are facing rating downgrades this year than the average in the past decade, Standard & Poor’s said on April 28. With Chinese corporate debt more than doubling since 2009 to $2.01 trillion, yields that investors demand to hold Asian junk bonds are approaching a one-year high as Premier Li Keqiang said more defaults may be inevitable.

“My concerns about Asian high yield are focused on the pace of private-sector credit growth,” Steve Drew, the head of emerging-market credit at Henderson Global Investors, which oversees about $126 billion, said by telephone. “It’s created potential systemic cracks and heightened idiosyncratic vulnerability, particularly in China.”

Industrial production in China has fallen every month this year, the longest slump since October 2012, according to HSBC Holdings Plc and Markit Economics. A property-market correction has begun as new home sales tumbled and “every leading indicator turned down in the first quarter,” Nomura Holdings Inc. said in a report May 5.

China’s economy will expand 7.3 percent this year, according to forecasters surveyed by Bloomberg. That would be the least since gross domestic product increased 3.8 percent in 1990. China is aiming for 7.5 percent growth, which would be the slowest since 1990.

On March 7, Shanghai Chaori Solar Energy Science & Technology Co. became the first company to default in China’s $4.2 trillion onshore bond market, while closely held Shanghai developer Zhejiang Xingrun Real Estate Co. collapsed two weeks later.

“The underperformance is coming mostly from Chinese property names, and when you have concerns about that sector, you’d be a seller rather than a than a buyer,” Leong Wai Hoong, a money manager at Nikko Asset Management Co., said by telephone from Singapore. “We’re cautious.”

Nikko, which manages more than $160 billion, has held a smaller proportion of Chinese debt compared with benchmark indexes for about two months, and is buying more higher-rated Asian debt securities, Leong said.

Evergrande Real Estate Group Ltd.’s $1.5 billion of 8.75 percent notes due October 2018 have lost 9.3 percent this year. Agile Property Holdings Ltd.’s $700 million of 9.875 percent notes maturing March 2017 fell 3.2 percent in that time.

Some of the biggest U.S. banks are also recommending clients retreat from Asian junk bonds. Goldman Sachs Group Inc. on April 4 said investors should reduce overweight positions on speculative-grade Chinese debt while Morgan Stanley last month reiterated their view that investors favor higher-quality debt amid default risks among the region’s weakest borrowers.


Record Sales

“The whole high-yield space in Asia is being driven by China risk,” Neal Capecci, a senior fixed-income director at Manulife Asset Management, said in an interview.

Asian companies are still poised to sell a record $150 billion of new debt this year, according to Morgan Stanley. At that rate, the size of Asia’s dollar bond market will reach $1 trillion by 2017.

Chinese issuers accounted for half of the $70 billion of U.S. currency debt offerings in the first four months of the year, with investment-grade notes comprising 80 percent of the total, the New York-based bank said.

Borrowers from Asia outside Japan issued $36.3 billion of U.S. dollar notes in April, exceeding January 2013 as the busiest month on record by 60 percent, Bloomberg data show.

China Petrochemical Corp., known as Sinopec Group, raised $5 billion in the region’s biggest dollar-bond offering in a decade, while Cnooc Ltd., China’s biggest offshore energy explorer, issued $4 billion of debt. Both are investment grade.

Cnooc’s $2.25 billion of 4.25 percent, 10-year notes issued last month traded at 100.5 cents on the dollar to yield 4.19 percent yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.


Expansion Moderating

“Credit risk is increasingly about funding, and the risks are increasingly in the tail,” Morgan Stanley said in an April 29 report. “Higher-quality credits are now actually improving while the weaker ones are deteriorating.”

Developing economies in East Asia will grow slower than forecast this year as China’s expansion weakens, the World Bank said in an April 7 statement. India’s rupee slumped to an all-time low in August while dollar-denominated corporate bonds tumbled 4.4 percent in their biggest rout in almost two years, reminding investors of the risks tied to economies which export more than they import and spend more than they earn.

“Rising current-account deficits have and will lead to further interest rate rises, which in turn will put more pressure on Asian credit growth,” Henderson’s Drew said. “Increasingly levered balance sheets, coupled with slower growth and tighter credit, are the hallmarks of a turning credit cycle going into late 2014.”

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