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Bond investors are playing with fire

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By Morgan Davis
24 Feb 2020

Asia’s bond market has had an undeniably stellar start to 2020. Despite the spread of the novel coronavirus, now named Covid-19, investors are continuing to buy bonds at remarkably tight prices as issuance accelerates. But the non-stop enthusiasm raises a serious question — are market participants too positive?

January’s deal flow in Asia was a blowout, despite an early Chinese New Year holiday that paused the dollar debt market for more than a week at the end of the month. As Asia prepared to reopen after the holiday, the Covid-19 outbreak took off, raising concerns that the market would slow to a near standstill until this health crisis was under control.

But that didn’t happen. Asia’s issuers and investors alike reopened the bond market quickly in February, placing bonds in the hands of eager buyers. Debt capital markets bankers see positive sentiment in the market, while investors have shown appetite for duration in search for yield.

That has changed little over the past few days, even as the epidemic’s death toll rises and global growth comes under immense pressure. Investors are still eager to put their cash to use, and see plenty of buying opportunities in Asia’s bond market.

The effect is apparent in nearly every transaction coming out of Asia, in the form of tightly priced bonds on the back of oversubscribed order books. Real estate company Yango Group Co, for instance, raised $300m from a 8.25% 2023 bond last week on the back of a $3.9bn order book. A number of Chinese issuers that don’t have regulatory approvals to sell offshore notes have skirted the approval process by sealing sub-one year tenor bonds to take advantage of a hot market. Zhenro Properties Group, for one, sold a $200m 363-day bond last week on the back of a $3bn book while it waits for its issuance quota to come through.

But as investors — both Chinese and international — throw their weight behind the bond market, it’s worth remembering that there can be too much of a good thing.

It’s great to see that Asia’s market can survive a hurdle like Covid-19, which is crippling parts of the region and has left countless businesses floundering as employees stay at home. Bond issuers’ and investors’ resilience, under the circumstances, is laudable.

Still, investors are worryingly optimistic, particularly about the fate of some Asian companies that have or will take direct hits from the virus outbreak. At this stage, there’s still a lot of uncertainty about Covid-19, how long the epidemic will last, and how global cities will be affected. The startling — and unexpected — rise in the number of cases in Italy over the weekend, for instance, has put European countries on alert, with more jumps in the number of infected expected.

There is little reference for Covid-19 either. When Sars broke out in late 2002 and spread in force in early 2003, Asia’s capital markets shut. But the bond market was just a fraction of the size it is today, and the effect of the outbreak on the market was comparatively muted.

China has stepped up in many ways. It has been discussing stimulus options to boost domestic spending and keep its economy on track, while cutting everything from the loan prime rate to the medium-term lending facility rate. It has also asked lenders to raise their tolerance for bad debt.

Investors may take comfort in this, seeing it as a sign of China’s willingness to support its economy. But they should not take the stimulus at face value. The artificial propping up of the economy isn’t necessarily the right move, no matter how bad the situation may be. The U-turn on deleveraging, particularly, can have big consequences.

Earlier this month S&P Global Ratings said that it may downgrade China’s A+ rating if the government uses excessive stimuli.

China’s government can’t save every one of the country’s floundering companies. Ultimately, some — perhaps real estate companies or local government financing vehicles based in the virus-ridden cities — will fall. The question is which companies will be left to their own devices and when.

It’s also worth remembering that at the end of 2019, there was an uptick in Chinese defaults. Last month, before Covid-19 spread, S&P wrote that government bailouts would be increasingly selective, as the country faces another record year of government debt. Those concerns shouldn’t go away, despite the regulators offering indebted firms some leeway amid the epidemic.

Investors should proceed with caution as they embrace the onslaught of dollar deals yet to come from Asia. Some opportunistic borrowers may offer enticing yields and tenors, but buyers should be wary about what’s on the table — or risk being burnt.

By Morgan Davis
24 Feb 2020