Zhi Wei Feng
Senior credit analyst
Standard Chartered Bank
While the value of Chinese high yield (HY) bonds at any point in time is arguable, they certainly guarantee investors a roller-coaster ride, either due to risk-on or risk-off sentiment in the market or company-specific issues.
Prices of China’s HY bonds ended 2011 between 5 basis points - 37 basis points (bp) below their tightest levels achieved in March/April 2011 but substantially higher than the lows recorded in September-October 2011.
This year started strongly, with a surprisingly bullish performance in the high yield space. Prices of China’s HY bonds rose between 5bp-23bp from their respective end-2011 levels to a year-to-date high in mid-March. However, market sentiment has turned cautious since end-March, with bond prices falling by about 1bp-16bp (or an average 5bp) year-to-date.
At current levels, we think credit selection is key to risk-compensated returns in the Chinese HY space. This is especially true in view of liquidity issues and the wide bid/offer spreads of the Chinese HY bonds. On the other hand, any negative surprises may cause a widespread sell-off of bonds given weakened market sentiment.
Taking the above factors into consideration, while we are neutral towards the Chinese HY property sector in view of the headline risk, we overweight the stronger names in this space – based on company-specific strengths such as financial position, market exposure and asset quality, as well as technical factors such as bond size, curve and maturity.
At yields-to-maturity of 9%-14%, we think the US dollar bonds from Chinese real estate companies offer good carry with upside potential and downside protection, despite China’s policy-driven property downturn. We believe a further correction in the country’s property market is likely. However, we think a market consolidation is good for long-term market stability and expect these developers to be able to weather a market consolidation.
In the HY industrial space we see name-specific risks, especially on the corporate governance front. Given that most of these companies do not have government links, they are operating in a more difficult environment characterised by a market downturn and tight financing. In this space, we like companies in domestic-demand driven sectors.
Pradeep Mohinani
Head of credit strategy, Asia ex-Japan
Nomura
China high yield bonds have rallied by an average of 5bp-10bp in January and February only to still trade at yields that are wider than that of US HY and emerging market (EM) corporate bonds. However, we believe the upside from here is likely to be capped with the current spread differentials to be maintained given the weak bond structure (implying low recovery), corporate governance concerns and new issue supply risk. We therefore expect carry rather than price appreciation is the key theme for the rest of the year.
We believe the current yields for China property and industrials bonds have largely priced a slowdown in earnings slowdown for 2012, reflecting lower sales volume and declining profit margins. That said leverage, albeit higher, should remain reasonable for most issuers. Overall, we prefer more defensive issues with the China property and industrial sectors instead of going down the curve in search of additional yield.
With large cap property bonds and the higher-quality industrial bonds trading at 10.5%-13.5% and 9.5%-11.5% respectively, there is better value in the large cap property bonds versus the industrial bonds. While the property sector is highly correlated to the industrial issuers engaged in steel, cement, heavy machinery and coal industries, the property sector is relatively more transparent with issuers providing monthly presales figures coupled with the sector better researched.
From a technical perspective, we may also see more new bond issuance from the industrial sector relative to the property segment though it will probably be limited to higher-quality credits.
Viktor Hjort
Credit strategist
Morgan Stanley
China high yield credit remains our preferred asset class in Asia, reflecting our increasingly positive view on credit conditions in China and the correction in valuations.
Credit conditions are improving in China. Credit data increasingly suggest that we have passed an important inflection point after nearly two years of tight credit. Recovering loan volumes are a positive, but the details are even more encouraging, and now points towards much better access to credit for private sector corporates in China, including property.
Improving credit conditions is the key catalyst for high yield bonds. We care about credit conditions because the market cares about credit conditions. China high yield has historically been very sensitive to turns in credit growth cycles and for good reasons.
We think improving credit conditions now support China high yield. It’s unloved, it’s under-owned. Sentiment remains negative and our estimates suggest that this is the biggest underweight among institutions involved in Asian credit markets.
Don’t expect the rising tide to lift all boats. Tight credit has taken its toll on corporate China and liquidity positions have deteriorated during 2011. We prefer higher quality property credits and expect the credit quality curve to remain steep at this stage.
We see two key risks to this call. First, banking system constraints may resurface and impede the credit recovery, which would require more aggressive policy action. Second, returning global systemic risks are a risk to this high-beta asset class, although we see reasons to feel sanguine about the latter and see important differences versus 2011.
Michele Barlow
Head of Asia Pacific credit and convertible bonds research
Bank of America-Merrill Lynch
We continue to find value in Chinese HY bonds after the strong year-to-date performance, although we think that the upside becomes more limited as prices approach par.
Our Chinese discount framework shows that Chinese ‘BB’/‘B’ bonds offer an attractive premium of 460bp/700bp to US ‘BB’/‘B’ bonds for differences in corporate governance, liquidity and transparency after accounting for lower expected recoveries.
The Chinese economy and fundamentals in the property sector appear to be bottoming out, which should support the credit outlook—although we do not expect a sharp rebound in the latter. We favour the larger, more diversified property developers over the smaller companies which are likely to continue to struggle with a far lower certainty in sales and weaker liquidity profiles.
We expect supply to pick-up as bond levels move towards par, which is likely to cap the upside. However we do not think it will re-price the space materially downward as we expect issuance to be used more for refinancing rather than expansion as was the case in 2010.
On this basis, we favour the ‘BB’ over ‘B’ space in China. Property bonds look slightly more attractive to industrials in the ‘BB’ space given a pick-up of 165bp, but not excessively so given higher outstanding supply in property.
Chinese ‘B’ industrial bonds are only providing a premium of 235bp to the US, which is not particularly enticing. While Chinese ‘B’ property bonds are offering a more attractive 860bp premium, we remain highly selective as we expect ongoing liquidity pressures.