Distress Signal: Risky Chinese Bonds Leave Investors Underwater

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11/29/2018 | 11:44 am

By Stella Yifan Xie and Saumya Vaishampayan

HONG KONG--Distress is spreading among Chinese corporate bonds.

Sinking prices in recent months have pushed dozens of Chinese companies' U.S.-dollar bonds into distressed territory, a sign of looming problems for investors and businesses as China's economy loses steam and its government struggles to channel financial aid to the private sector.

Emerging-markets debt has suffered broadly, but trade tensions, default fears and tighter credit in China have caused a deeper selloff in non-investment-grade, or junk, bonds from Chinese companies.

"China has become the most risky emerging market in terms of perception, " said Amy Kam, a bond investment manager at GAM Investments.

Bonds are generally considered distressed when their yields are more than 10 percentage points above those of comparable U.S. Treasurys. At these levels, investors see high default risk and want to be compensated for it. Bond yields rise when prices fall.

At the start of this year, just seven of the 200-plus Chinese high-yield bonds in a JPMorgan emerging-markets corporate-debt index were trading at distressed levels. Now, a quarter of the group is.

The malaise is a turnaround in what had been a growing segment of global emerging markets in recent years. Issuance of speculative-grade bonds from Chinese companies hit a yearly record of $42.7 billion last year, more than double the volume in previous years, according to Dealogic.

Chinese companies flocked to the global capital markets in recent years because borrowing offshore was cheaper than in mainland China, where credit conditions were less hospitable. Low yields on U.S. Treasurys, the benchmark for dollar bonds, helped, as did strong demand from both foreign and Chinese investors.

This year issuance is down about 13%. Many would-be buyers have backed away, sending borrowing costs surging for developers, airlines and other companies.

Value Partners, a Hong Kong-based money manager, identified 100 U.S. dollar bonds of non-state-owned Chinese enterprises trading at yields of 13% or higher. Most are scheduled to mature within the next two years.

"China has become the most risky emerging market in terms of perception, " said Amy Kam, a bond investment manager at GAM Investments.

Some bonds have lost 20% to 50% of their value in a matter of months. Huachen Energy Co., which produces and sells electricity in two large regions in China, raised $500 million in May 2017 in its maiden sale of U.S. dollar bonds with a coupon of 6.625%. Its bonds plunged over the summer and were recently trading at around 50 cents on the dollar, according to Refinitiv.

Huachen's finances and cash flows have been sound, but its parent, coal miner Wintime Energy Co., defaulted on onshore, yuan-denominated debt in July, and investors fear it could sell some of Huachen's assets to repay creditors.

Huachen missed an interest payment on its bonds this month. It will be in default if it doesn't come up with the cash by mid-December.

Chinese debt defaults, still rare by global standards, are rising. Seven dollar bonds with a combined value of roughly $2 billion have defaulted this year, according to Fitch Ratings, which expects more losses in the coming year. Earlier this year, the sudden default of more than $1 billion in dollar bonds issued by a Chinese energy company cost many investors, including financial institutions as far away as South Korea that had purchased investments backed by the debt.

Most vulnerable are debt-laden companies not backed by the state. Many investors believe government support makes state-owned enterprises far less likely to default, and Chinese banks have long had a lending bias in favor of them.

Private enterprises are still generally able to sell new high-yield bonds, though some recent ones let investors demand repayment in two years or less. "People are shying away from longer-term debt," said Baoshu Huang, Head of North Asia Debt Markets at ANZ.

They are also demanding to be paid more for the risk. Yields on lower-rated junk bonds issued in the past month or two have been in the 13% to 15% range, Mr. Huang said, compared with 8% to 9% a year ago. Still, he expresses optimism about 2019. "I don't think the market is concerned that defaults will become the new norm in China," he said.

Many market participants expect Beijing to provide more support to private enterprises, especially real-estate companies that need to refinance debt. Authorities have repeatedly pledged more backing for private companies, which have primarily relied on the country's now-shrinking shadow banking sector for funding. China's central bank last month said it would provide 10 billion yuan ($1.44 billion) as credit support for private companies' bond sales.

Omar Slim, a fixed-income portfolio manager at PineBridge Investments in Singapore, said he's taking a more cautious approach to high-yield debt in Asia. "You need to keep avoiding land mines," he said.

Write to Stella Yifan Xie at stella.xie@wsj.com and Saumya Vaishampayan at saumya.vaishampayan@wsj.com

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