Chinese companies are responsible for fully half of emergingAsia'sjunk bond issuances
Chinese companies are nursing a mountain of dollar debt. This is a relatively new phenomenon, and their ability to service this debt may soon be severely tested. A worsening economy, an interest rate hike, further weakening in the value of the Chinese yuan, or a combination of such pressures could stretch their limits.
The past decade has seen a frenzy of debt-raising theatrics in emerging Asia, which includes all Asian countries except Australia, Japan and New Zealand, and Chinese companies have been the most aggressive.
One-third of emerging Asia’s overall foreign-currency debt is in China, up from virtually zero a decade ago. Especially in junk bonds, also known as high-yield bonds, no country can compare: Chinese companies are responsible for fully half of emerging Asia's junk bond issuances, of which dollar-denominated high-yield bonds are worth $139.8 billion.
In the first quarter of 2015, emerging Asia piled up $149 billion in debt, 23% more than the same period a year ago, though the pace was slightly less frenetic than the preceding quarter.
“You have an entire range of Chinese high-yield bonds emerging as an asset class,”says Vijay Chander, executive director of fixed income at Asia Securities Industry & Financial Markets Association. “We’ll have to see if, even in a downturn, the market can continue growing, whether investors will become a little bit scared and stay away from the sector if these companies default.”
Even so, he adds, “I am very optimistic. I think the sector will continue to grow.”
Not everyone shares his optimism. Lately, investor sentiment has soured noticeably. In a credit report issued on August 17,
Moody’s, the rating agency, came up with a similar assessment on September 1, saying most of the 70 Chinese utility, infrastructure and non-property companies it rated held 48% of their debt in currencies other than the yuan, and that they could withstand a 10% depreciation of the yuan, including the 2% weakening the currency suffered on the fateful day of August 11.
Standard Chartered views interest rate hikes as the greater risk. “Our sensitivity study shows that a change in the interest rate would affect companies’ cash flow and credit metrics more than a currency depreciation would,” and that “interest savings from every 1% drop in the interest rate are much more than the increase in interest costs from a 10% currency depreciation.”
A rate hike by the Fed would also force the hands of Asian central bankers, who would have to respond by raising rates at a time not to their liking.
Asian interest rate spreads (relative to those in the United States) are already very compressed. Were they to return to historical levels, interest rates in this part of the world would increase by 3%, or even 5% or more. Given current low policy rates, central banks in the region would have difficulty offsetting a shock of this magnitude. Borrowers could be in trouble, with domestic banks in Asia likely facing hefty losses on their balance sheets.
“If things go wrong, it could be terrible,” a Hong Kong-based lawyer says, referring to risks inherent in China-issued offshore bonds. As it stands, offshore debt issued by many emerging economies, China included, is structurally subordinated to onshore debt, meaning the rights of offshore creditors are legally subordinate to those of local creditors, including banks, company staff, and builders of company buildings. In a distressing event, local creditors would take precedence over offshore investors.
“Normally when they (companies) cannot pay offshore debt, they cannot pay onshore debt (called cross default). It’s risky. That’s the nature of this product. It would be difficult to get the money to pay offshore creditors,” the lawyer says. When a company defaults on its debt, he notes, normally it involves a ‘cross default.’
Admittedly, China’s junk bonds are issued by companies considered the cream of the crop, the very best of corporate China, which have secured offshore listings outside China before proceeding to issue foreign-currency bonds.
Yet, a particular cause for concern is China’s property developers, which together account for 42% of Asia’s high-yield bonds. Offshore financing has become a popular means for them to raise funds at low cost, since domestic regulations bar them from using bank loans to acquire land. The industry’s size and close correlation to the macro economy also make property developers an ideal proxy for international investors who wish to place their bets on China.
In April, investors were spooked by the first default of a Chinese developer, Shenzhen-based real estate developer Kaisa, whose fate remains uncertain. And in September, Shanghai-based residential property developer Glorious Property Holdings caused jitters by falling behind in payments on nearly 10.5 billion yuan ($1.64 billion) in loans.
Nicole Wong, regional head of property research at CLSA, thinks the property market is too important a sector for the Chinese government to ignore when things go amok. Still the depreciation of the yuan represents a long-term refinancing risk for Chinese developers, she says.
A junk bond crisis in China, should it happen, would be a sideshow of a larger regional currency crisis. Kevin Lai, chief economist for Asia ex-Japan at Daiwa Capital Markets, believes the total dollar leverage in China could be closer to $3 trillion, about one-third of all dollar debt outside the U.S. and three times as much as the $963 billion estimate by Bank for International Settlements.
Lai’s figure includes dollar-denominated debt taken by offshore subsidiaries of Chinese companies and developed-world borrowers that brought dollars to emerging economies by taking on dollar debt.
Most of the dollar debt taken on by Hong Kong and Singapore is essentially debt they have raised on behalf of China, he notes.
The question is whether the market has become too complacent, too optimistic, to anticipate a looming scenario that may turn into a nightmare.
LIANYUNGANG, CHINA: A staff member counts money at a branch of the Bank of China on August 10, 2011... [+] in Lianyungang, Jiangsu Province of China. (Photo by ChinaFotoPress/Getty Images)
