China defaults may worsen with huge dollar debt

Hong Kong

A RECORD pace of defaults has hit China's domestic bonds this year. In 2020, it could be the offshore market's turn.

That's because of a looming wall of dollar debt, issued by now-stressed borrowers, that comes to maturity. There's US$8.6 billion of offshore bonds coming due next year that currently have at least 15 per cent yields - classifying them as stressed, according to data compiled by Bloomberg.

Put another way, nearly 40 per cent of total outstanding corporate dollar bonds from China's most troubled companies is due next year. With Chinese policymakers emphasising the need to continue a campaign to limit leverage, it suggests a pick-up in defaults. For those lured by juicy yields in today's low-rate universe, that means danger.

"This is a market where you want to go for safer bets rather than be a hero," said Michel Lowy, chief executive officer at Hong Kong-based SC Lowy, which specialises in fixed income. "We are on the verge of a massive snowball effect," where defaults spur funds to take money out of high-yield debt, driving up yields and making it all the harder for firms to refinance, he said.

Mr Lowy advises sticking with companies with strong cash flows.

Trouble is, a swathe of the borrowers with debt due next year lacked strong fundamentals, and took advantage of unusually sweet financing conditions back in 2017 - the year of the synchronous global expansion. That's according to Wonnie Chu, managing director of fixed income at GaoTeng Global Asset Management Ltd.

"A lot of them were issued with a low interest rate not comparable to the credit risk," she said. Ms Chu predicts a full-blown shock will be avoided as enough investors have already begun to anticipate problems.

Indeed, money managers have already started slashing their holdings of riskier companies. Asian high-yield credit funds saw a near 3 per cent outflow from their assets under management in August, according to Morgan Stanley. (Asian high yield is dominated by Chinese issuers.) At the same time, funds that focus on Asia investment-grade saw an inflow close to 1 per cent.

Another sign of investor concern: prices in the secondary market have slumped, driving up yields. That's spurred a doubling in the amount of Chinese dollar bonds with stressed-level premiums since March.

The following are a few of the issuers with bonds coming due in 2020 that currently have stressed-level premiums. The selection underscores the diversity of indebted businesses, but doesn't imply that these are more strained than others.

Ten of the 25 are property developers. More broadly, real-estate firms have US$30 billion of dollar debt due next year, amid continuing efforts by authorities to tamp down property-price inflation.

Any refinancing crunch could offer opportunities. Mr Lowy says "we are positioning ourselves with alternative capital that we can syndicate to investment partners with private money to refinance some of those debt obligations". China's high-yield dollar-debt issuers tend to have higher default risks than peers abroad, according to Morgan Stanley research. That's because of relatively short bond-maturity profiles - at close to 2.5 years, Kelvin Pang, head of the bank's Asia credit strategy team in Hong Kong, wrote in a note earlier this month.

High-yield issuers' loans maturities are also of shorter duration, at one to three years, Mr Pang wrote. It all means that "China corporates are extremely sensitive to credit conditions", he wrote.

Bottom line, according to Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group: "Next year, as the maturity wall comes, the default rate is likely to increase" in the Chinese dollar-debt market. BLOOMBERG