It has been raining high-yield bonds this year making it an extremely busy time for money managers like us. There have been times when I have attended a lunch road show on each day of the week from Monday to Friday.
According to some estimates, high-yield U.S. dollar bond issuances for Asia ex-Japan totalled US$ 8.8 billion during the first quarter of 2011, a level never seen in the past. So why has there been a sudden frenzy in high-yield bond issuances? There are two main reasons:
1. Fears about U.S. raising interest rate in second half of the year: U.S. investors are major source of funds and liquidity in Asian high-yield bond markets. If the U.S. was to hike interest rates soon, as hinted by some regulators, the high-yield bond market there would become equally attractive to these investors that too without having to bear the ‘country risk’ of Asian economies. Issuers, who are very ably guided by their investment bankers, realise this and are rushing in to raise capital before that happens.
2. Expensive to raise funds in domestic currency: China raised their benchmark rate recently. Many other Asian countries have been stepping up their policy rates in order to combat inflation. However these moves are having an adverse effect on their domestic bond markets. As a result local companies are finding it cheaper to raise debt in U.S. dollar as compared to their local currency.
OUTLOOK FOR HIGH-YIELD BONDS IN 2011
I would segregate my viewpoint in two parts:
1. NEW ISSUES
I don’t expect any slowdown in the number of issues coming to the US dollar market as long as U.S. doesn’t raise interest rates.
China: China’s real estate sector has dominated the high-yield issuances for better part of the year so far with Longfor Properties & Franshion Properties being the latest ones to come to the party. Consequently investors have gladly welcomed greater diversity in issuances from PRC. This includes names like Texhong Textile, the first Chinese textile firm to issue dollar-denominated bonds; West China Cement, the first Chinese cement company to tap the dollar market and very recently Fufeng Group, the largest manufacturer of Monosodium Glutamate (MSG) in China.
Recent Chinese non-property high-yield issuances:
I foresee this trend continuing for rest of the year and envision more non-real estate Chinese companies hitting the dollar market to raise funds.
Indonesia: There have been only two Indonesian high-yield issuances this year as compared to almost two dozen from other Asian jurisdictions. The main reason for this anomaly wasn’t the availability of better fundraising alternatives for Indonesian companies but a rule by Bapepam, the capital market regulator that restricted offshore bond issuances. According to a 2009 disclosure rule, before a company planned on a bond offering, it had to reveal detailed information about the same to the shareholders, such as coupon & issue size. This didn’t fit in with the general market practice of bond offerings where price and size are key aspects of book building and issuers (along with their bankers) want to maintain absolutely secrecy before the transaction is announced.
However recently Bapepam has issued a draft revision in which it proposes to waive this requirement. The only disclosure the Company would now need to make to its shareholders shall be the purpose of fund raising. While bankers and domestic companies are still not completely satisfied with this proposal, it allows them just enough room to get bond deals done. Consequently I expect a good number of Indonesia high-yield bonds to come to the market over the next 6-9 months.
2. DEFAULTS AND CORPORATE GOVERNANCE ISSUES
China Forestry Holdings, a Hong Kong-based tree plantation company in which The Carlyle Group owns approximately 11% issued US$ 300 million in senior notes due 2015 on the U.S. dollar market in November 2010. The deal was underwritten by Deutsche Bank, Standard Chartered and UBS. Few weeks later the auditors found accounting irregularities in the Company, thereby prompting Hong Kong regulators to suspend the company’s stock from trading. The regulators later froze assets of the CEO and initiated court proceedings against him. Some fund managers call this case an exception while others describe it as ‘the tip of the iceberg’.
In my personal opinion, this case typifies the pitfalls of rushing in to put money at work in Asian high-yield space. I won’t be surprised if as much as a quarter of the high-yield bonds issued over the last few months default on their coupon payment or have corporate governance issues by mid-2012.
The reason is simple : many weak & dishonest companies are opportunistically tapping the U.S. dollar bond market at the moment and managing to raise fund thanks to yield hungry investors from America and Europe who are investing in almost anything in the name of ’emerging market exposure’.
Pitch books are put together hurriedly (and carelessly), road shows are organised around the globe in a jiffy and the next thing you know – the issue has been oversubscribed six times! There are instances when the participants don’t even get a day to do their due diligence on the Company and yet compete with each other to get some allocation because of the fear of ‘missing out’.
If there are a series of missed coupon payments, corporate governance issues or accounting scandals over the next few months, the cat shall be set among the pigeons. Since overseas investors have little recourse in debt defaults in Asia, the panic-stricken fund managers shall offload these (at a huge loss of course) and might end up throwing out the ‘baby with the bathwater’ thereby creating attractive opportunities for funds that do their homework correctly.
In conclusion, I would compare the current high-yield bond market in Asia to a valley of flowers laden with land-mines. It appears very attractive from outside but can blow up in one’s face if one doesn’t tread carefully.
(Tanuj Khosla is currently working as a Research Analyst at 3 Degrees Asset Management, a fund management firm in Singapore. He can be followed on Twitter @Tanuj_Khosla. Alternatively he can be reached at [email protected] Views expressed are personal.)