Chinese coupon cuts: A dangerous game
Chinese issuers have been slashing the coupons on their onshore puttable bonds in an attempt to save money. They are playing with fire.
More Chinese issuers of puttable bonds have, in recent months, chosen to announce reductions in the coupon rates for the remainder of the bonds’ terms, data from Wind and onshore securities houses showed.
These include high profile names such as one of the country's largest real estate companies China Vanke, which said last week that it will adjust the 4.5% coupon on a Rmb3bn five year non-put three bond to 1.9% from the bond’s put date of July 18. Investors will have to decide whether they wish to hold the notes for another two years at a 260bp lower interest rate, or sell the bonds back to the company and look for yield elsewhere.
The developer joined its peers China Fortune Land Development (CFLD) and Yango Group, which made similar decisions earlier this year. Property companies sell more puttable bonds than those in other sectors. Almost all of these bonds give them the option to change coupon rates at the first put date.
Developers are not the only ones joining the trend. State-owned and private companies across different industries have been doing the same. Many have gone even further than Vanke, reducing coupons by 300bp or 400bp. In some cases, the cut was as steep as 770bp.
In most cases, the move makes sense. Issuers are only taking advantage of a possibility that is clearly spelled out in prospectuses (in most cases, at least). Given the sharp fall in funding costs in China’s domestic market, investors can hardly expect to keep enjoying the same high coupon rates.
But some issuers are pushing their luck. Some of the coupon cuts are beyond reason — reductions by 300bp, 400bp or even more that push these bonds well inside comparables. The intention is clear: issuers want to force investors to exercise their puts. That is a risky strategy.
By attempting to force investors’ hands, issuers could harm relationships with investors. Those relationships are something these companies will need to rely on, if onshore funding conditions tighten again. China now appears to be coming out from its coronavirus crisis, but there are still big sources of uncertainty for borrowers that should make them cautious.
The main concerns are the long term economic impact of the coronavirus, the direction of the trade war between China and the US and the ramifications of China’s move to reduce Hong Kong’s autonomy. China’s monetary and fiscal authorities will need to be nimble to deal with risks this year. They can cause further problems by doing too little, or doing too much.
This is a time for Chinese bond issuers to be strengthening their relationships with investors, not weakening them. That does not mean corporations shouldn't cut coupons when their bonds become puttable ─ they would be foolish not to. But they should ignore the temptation to sneak through a coupon change that gives them a few years of discount funding but loses any trust they may have built with their investor base.