Chinese Property Firms’ Junk Bonds Started 2014 Fast but Have Soured

Chinese Property Firms’ Junk Bonds Started 2014 Fast but Have Soured

FIONA LAW

Jan. 27, 2014 6:11 a.m. ET

Chinese issuers of junk bonds got off to a fast start in 2014, but concerns about weakening economic growth and the likelihood of a high-profile loan default are putting investors off.

Chinese real-estate developers in particular opened up a wide lead on the Asian pack in terms of high-yield bond issuance in advance of the Year of the Horse, but now they are leading the way regionally in a broader emerging-market selloff.

Chinese property developers raised a combined $4.55 billion by issuing junk, or non-investment-grade, bonds in the first three weeks of the year, accounting for 11 of 12 such issues in Asia outside Japan, according to data provider Dealogic. That is not far off the record pace set in the same period last year, when Chinese companies issued $5.87 billion in junk bonds. Meantime, total junk bonds for Asia, excluding Japan, shrank 40% to $4.77 billion.

The Chinese firms sought to extend the pattern, set over the past two years of tapping bond buyers who were on the hunt for higher yields in growth markets against a backdrop of ultralow interest rates globally amid central banks’ loose monetary policy. But unlike last year, when bond prices soared, the new debt has turned sour immediately after issuance.

KWG Property Holding Ltd. 1813.HK -0.73% , a large developer, saw its five-year bond fall roughly 2% from its issue price, while notes from CIFI Holdings (Group) Co.0884.HK +0.63% , a smaller player, fell around 5% within a couple days of its issuance. Bond prices of peers who issued debt with investment-grade ratings also softened: China Overseas Grand Oceans Group Ltd.’s five-year bond, for example, fell by around 1%.

“Obviously Asia cannot escape from global emerging-market weakness, despite the fact that most Asian countries are not battling the same level of currency volatility or political instability seen in some other emerging regions,” said Mark Reade, credit desk analyst at Mizuho Securities Asia Ltd. “Chinese high-yield bonds have been harder-hit than their investment-grade counterparts as tight onshore liquidity conditions have stoked concerns about a deluge of offshore high-yield supply, not to mention rising refinancing risk among smaller, weaker corporates.”

Investors have veered sharply away from risky assets in global emerging markets, with Argentina’s peso and Turkey’s lira having taken serious knocks last week.

In China, property bonds started getting squeezed after a weaker-than-expected initial reading on manufacturing activity last week, exacerbated by mounting pressure that could lead to an unprecedented default on a trust product sold by Industrial & Commercial Bank of China Ltd. Bond prices are off their their lows since news emerged Monday that China Credit Trust Co., the Chinese lender behind a troubled $500 million investment product, appeared to have found a way to pay back investors.

Real-estate developers in the country needing funds to acquire land or build projects but unable to secure loans or raise cash onshore given the government’s effort to rein in a housing bubble, tend to tap offshore markets for funding when they are favored by foreign investors. Housing prices in China picked up modestly in December compared with November, according to the latest data, and most property firms still see healthy cash flow amid robust contract sales, analysts say.

But Morgan Stanley warns that these property firms are vulnerable to tighter credit conditions in the domestic market and slower sales growth. The Wall Street bank recommends reducing exposure to Chinese high-yield bonds in favor of higher-rated issues.

In a sign of just how shaky the country’s debt market has become, Dalian Wanda Commercial Properties Co.—one of China’s biggest real-estate players, which has an investment-grade rating—sold a $600 million 10-year bond with 7.25% yield, even higher than rates offered on some junk bonds. The company is eager to secure funding ahead of any spike in global interest rates, a person close to the deal said. Higher rates are widely anticipated as the U.S. Federal Reservescalesback its bond-buying program

, a process known as “tapering.”

“The market is really choppy these days,” with the preponderance of news stories weighing on market sentiment, said Gordon Ip, a fixed-income portfolio manager at Value Partners Group Ltd. 0806.HK +0.39% , which manages $10.5 billion of assets.

Value Partners didn’t participate in the recent Chinese junk-bond issues, as “we think their pricings were too expensive” given the respective companies’ fundamentals and the macroeconomic environment, he said, adding that he is parking some of his funds in more “defensive” assets, such as bonds issued by banks for capital replenishment.

Reduced appetite for junk bonds, both in China and in the rest of Asia, is part of a “macro theme that developed markets continue to fare better than emerging markets,” said Arthur Lau at PineBridge Investments, which manages $69.1 billion of assets globally.

“Funds, especially retail funds, are pulling out from emerging markets, especially those invested in marginal credit such as Mexico, Turkey, Indonesia and India, which are vulnerable to U.S. tapering,” he said. “So far this year, though, we still see institutional funds continuing to flow into Asia, but at a much slower pace. We are more selective in tapping junk bonds, and wouldn’t buy them across the board.”