By some accounts, credit analysts view Asia’s credit markets as dislocated, hence offering good investment opportunities for the brave. Jenny Zeng, CIO of fixed income at Asia-Pacific, Allianz Global Investors, argues that now is the time to wade into the Asian credit market. More than that, she believes that Asian high-yield is in the right part of the credit cycle. The caveat is — the base case has to be a US soft landing scenario, where the Federal Reserve starts to cut interest rates later this year.
The most opportune time in the credit cycle is when corporates are wading through tough times; they start to repair their balance sheets just as the business cycle reaches a trough. Once that is done, the corporates will want to look for growth. At the bottom of the market, credit is hard to come by; banks are reluctant to lend. Stressed corporates have to get their funding somewhere else; 21% of high-yield debt matures between now and 2025; and at the right price, credit is available.
“In Asia, the majority of the corporates are in the sweet spot of the credit cycle. It means they are pretty much done with the down cycle and are beginning to enter the repair-and-recovery stage, before moving on to an early-expansion stage. Only a few sectors — including China property, Hong Kong property and a few Korean corporates — are still in a down cycle, but they’re close to the end of that cycle,” Zeng elaborates.
That is where a credit analyst would want to take credit risk, in the early stages of an expansion cycle. “For example, Indian infrastructure such as airports — their balance sheets are strong enough so we don’t worry about re-leveraging. Asian infrastructure in general is in an expansion cycle but they have strong balance sheets,” Zeng says.
Dislocation opportunity
Historically, no matter the credit market — US or elsewhere — the biggest opportunities are created and captured towards the end of the down cycle, i.e. when the default rate starts to come down, or the market remains dislocated, Zeng points out.
On the Chinese property market, Zeng says: “Sentiments are very fragile around Chinese high-yield. That’s why you still have market dislocation, but we have started to see dislocation receding. But that’s probably the only credit market where you can still find a double-digit yield nowadays.”
Even then the Chinese property sector is bifurcated where offshore bonds are going through a default cycle because offshore bonds are subordinate to onshore bonds as offshore bonds may not have access or claim to onshore assets.
“Subordination is not a new risk. The China market has been like that since the first day they issued the offshore bond market. Everyone should know that this is a subordination risk that they’re taking whenever they’re buying into the China offshore bond sector,” Zeng cautions.
See also: US bond market halts brutal run as buyers pounce on 4.5% yields
The most recent default is probably by Chinese education firm XJ International Holdings Co defaulting on US$315.1 million ($420 million) of convertible bonds. Kaisa Group Holdings’ court hearing in Hong Kong is adjourned till April 29. The lawsuit was filed by Singapore-based hedge fund Broad Peak Investment Advisers last year. Kaisa must show progress on restructuring to avoid liquidation. According to OCBC Credit Research, Kaisa’s debt-recovery ratio would be about 5% if any liquidation was eventually ordered. On March 13, Country Garden Holdings Co had not paid the coupon for its onshore 4.8% RMB bond maturing in 2026. Country Garden defaulted on an offshore US-dollar bond in October.
Lots of opportunity, says KKR
In a March report this year, global investment firm KKR says a wave of defaults amongst Chinese real estate developers catalysed “a wide reset in asset valuations that extended beyond the property sector, dramatically shifted the composition of the market, and eroded investor confidence” — hence the opportunity in Asia.
“The composition of the market creates what we refer to as No Man’s Land: a gap in the market where credits may have been technically impacted rather than fundamentally,” the authors (who are partners and managing directors) of the KKR report point out.
Investing ideas from KKR include investment grade (IG) assets (BBB+) trading at a relatively low price level due to the sell-off. “An investor can achieve a yield of 6.3% as of Jan 31 for IG risk. Select IG names offer high single to low double-digit yield with upside price convexity, creating a strong total return potential,” the KKR report says.
High-quality convertibles (BB-
rated), with puts that provide protection for the bondholder, offer an avenue for both upside potential and downside protection. These structures tend to be more borrower-friendly, with protection for the investor in a downside scenario, and could offer potential upside in the event of a conversion, KKR points out.
“We believe issuers in Hong Kong with offshore assets and more limited exposure to China could have attractive upside potential given the residual overhang from China’s real estate reset. We see value in select BB & BBB-rated insurance or financial names that have strong fundamentals, durable cash flows, and offer an attractive entry point,” KKR says.
Zeng believes China’s offshore bond defaults also provide the visibility needed to pick the survivors. “There may not be that many developers left and we can pick the winners. The property market remains essential to any economy regardless of its development stage. Through proper credit research, we can pick up the names that’ll eventually survive this down cycle.”
