The reason why Asian high-yield is dominated by Chinese property companies is that sector has been issuing the longest.
“Those names have been issuing for 20 years, so investors have some level of confidence – a lot of these names have issued bonds in that time, people have seen them and they haven’t defaulted. Other high-yield sectors, like China industrials, or Indonesia high-yield, for example, don’t have that history,” says Lee.
“It’s not wholly a Chinese story, but that is the main driver of the issuance.”
Many of the Chinese developers have found themselves unable to fund themselves domestically in the renminbi (RMB) market, because of tighter credit conditions, so they had to go to the international bond market and issue in $US to raise money.
Lee says that explains the surge in high-yield issuance toward the end of 2018 and the beginning of this year – issuance that has been snapped up by investors because of the yield premium.
“High-yield Chinese property companies have been offering anywhere from 7 per cent for a relatively blue-chip BB/Ba2-rated company to as high as 10 per cent to low teens, depending on the quality of the issuer,” he says.
“In US dollar terms, if you’re buying two-year or three-year paper, you get a 10 per cent annual return from a Chinese property company: obviously with yields where they are, it is hard to get that kind of return in other fixed-income markets around the world.”
But this is very much a 'buyer-beware' asset class. “You get paid that return because Chinese property development is a highly volatile market – you’re buying paper from issuers who are rated ‘high yield.’ Some of them have actually defaulted in the past, so they certainly don’t come without risk,” says Lee.
For example, unrated property developer Kaisa Group – which was the first Chinese developer to default on offshore bonds, in 2015 – has returned to the market, raising $US400 million in two-year bonds, but needed to offer a coupon of 11.75 per cent to get them away.
“There are no lenders onshore, so a lot of companies whose debt was maturing have had to go offshore, and they’ve had to pay up for it,” says Lee. “That range of 7 per cent to low teens is a high return even in a high-yield world: but they had to pay that, because international investors only want to buy this sector if they are well-paid for it.
''It’s a highly volatile sector and recoveries are low: China doesn’t really have bankruptcy laws, and it is certainly not as transparent a legal system as Australia’s or Japan’s, for example.”
The natural buyers of this kind of paper are private bankers, hedge funds, wealthy individuals, and some family offices, Lee says. “What’s generally called ‘fast money’ – they tend to like high-yielding products. You might have some ‘real money’ managers, which are mutual funds, those whose mandates allow them to buy higher-yielding assets.
''But it is usually the more ‘fast money’-style investors, because it’s not a hugely liquid secondary market, at all. Most of the issuance in China property has been at the shorter end, three to four years, because investors don’t really want to hold a high-yield China property company for longer than that.”
And because the high-yield market is dominated by Chinese property businesses, it is problems in that market that investors fear the most.
“The China property market has had a big run in recent years, and a lot of money has gone into that sector, but it’s in a bit of a halt now. No one can call it a bubble, but that’s why it’s called a bubble. If we were to see a big fall in property prices, that would certainly hurt that issuance market,” says Lee.
The market is also highly sensitive to the global macro environment – and geopolitical twinges – but ultimately, it is defaults that hurt it most.
“If investors start to see a higher level of defaults than they were expecting, that would hurt the market as well,” Lee says.
This article was first published on April 5 2019 in the Australian Financial Review’s Special Report on Rise of Asian Liquidity