AFTER a bruising rout, emerging-market junk bonds are scaling a golden mountain. Credit seems like the right place to be these days. Since a low in late November, Asia's high-yield corporate bonds have already risen more than 4 per cent, while emerging-market stocks have been trading sideways.
In this lower-for-longer rate environment, junk issues are seductive. Since November, China's real estate developers - the elephant in the market - have been racing to raise US dollar bonds, at the expense of offering average interest payments of about 10 per cent. Meanwhile, because of their high-yield nature, these issuers tend to sell bonds with two-year maturities. What are the chances that a developer will default in such a short amount of time, now that Beijing is loosening credit? The sweet double-digit yield seems worth the risk, the reasoning goes.
Think again. If the outlook for junk issuers has improved so much, why are they not raising bonds at home? With Beijing opening the tap again, they should be able to do so more cheaply. The central bank's more dovish stance has pushed the two-year sovereign yield to 2.6 per cent recently from more than 3 per cent in September.
China's high-yield developers have raised close to US$15 billion offshore since November, but they still cannot finance onshore. It is possible that Beijing is simply paying lip service by promising to ease the private sector's pain without really opening up the tap. More likely, banks and fund managers in China are too scared to dip in.
To be sure, China's property developers have a lot of US dollar obligations to pay off. They have even more in yuan. The sector needs to refinance six trillion yuan (S$1.2 trillion) worth of liabilities this year, estimated Sinolink Securities Co, a local brokerage. Because of tight financing in 2018, private enterprises will have a particularly hard time servicing this debt. On average, they paid a 7.49 per cent coupon for their bond issues.
There are already red flags in the US dollar bond market. Jiayuan International Group Ltd issued a one-year bond at 12 per cent in November, before a flash crash that sent its stock down 89 per cent. This real estate developer operates in tier-two cities at best - in 2018, its average selling price was only 11,292 yuan per square metre - and can generate a return on assets of just 5.7 per cent. How investors believe that the company can service a 12 per cent cost of debt is a mystery. Home-price growth in tier-two cities has lost momentum since September.
And then there is China Evergrande Group and its insatiable appetite for US dollar bonds - even if it means that chairman Hui Ka Yan has to buy a substantial chunk himself. The company requires long-time supporter Chinese Estate Holdings Ltd to prop up its stock and bond offerings. This week, Evergrande raised another US$3 billion of debt, on the heels of US$2.8 billion in November by its subsidiary Hengda Real Estate Group Co, which owns the group's property development assets in the mainland.
That begs the question of why the company is issuing bonds at the group level this time, and how it plans to use its proceeds. On this week's conference call with investors, Evergrande said that funds raised by the parent group may be used for ventures beyond real estate, including tourism, health care and new industries.
Lately, the company has been enamoured of electronic vehicles, pledging US$2 billion for startup Faraday Future. This month, the developer paid US$930 million for a Swedish electric vehicle company and over one billion yuan for a Chinese car battery maker.
It all feels too familiar: Mr Hui loves branching out into new businesses. In 2013, Evergrande entered the mineral water market, only to abandon the endeavour three years later because of a heavy debt load.
I get why investors prefer credit to equity these days. Now that we no longer see the Federal Reserve raising rates this year, a major overhang has been lifted for emerging markets' US dollar issues.
Stocks, on the other hand, need better earnings prospects, which no one is expecting. After all, the International Monetary Fund just lowered its global economic outlook again. But debt buyers, beware. The double-digit yield that you are getting comes with lots of strings attached.
- The writer is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
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