Participants in the roundtable were:
Fred Teng, executive director, head of high yield product group, debt capital markets, Greater China capital markets, Standard Chartered
Albert Yau, chief financial officer, CIFI
Paolo Danese, moderator, GlobalCapital
Global Capital: What has been driving the buoyant Greater China high yield market?
But the regulatory environment has had an impact on the offshore market. The slowdown in 2015 and the first half of last year was because of the liberalisation of the onshore market.
Most Chinese issuers have renminbi revenues, so there is a natural attraction to borrow in RMB to reduce FX exposure. Issuers were naturally attracted to the onshore market when it was available for them.
From the middle of last year they tightened up regulations for real estate sector issuance onshore and everyone had to come back offshore to issue bonds. However, this past quarter there has again been some tightening up, with NDRC [the National Development and Reform Commission] slowing approvals for new offshore issues.
I expect the power sector or sectors related to infrastructure to be doing more investments in these countries and, therefore, also increasing their needs for offshore financing. In terms of diversity, looking back maybe five, six years ago you’re talking about more of an 80%-90% market share for real estate, but I think that has shrunk to maybe 60%-70%.
Eugene Fung, BFAM Partners: On the non-real estate side there are definitely industrial names that are interesting. Diversification is good but I do think the process is important. For some industrial names we can do proper due diligence for an initial issue, but there are others that come across as somewhat fly-by-night.
|Gerhard Radtke |
Davis Polk & Wardwell
Gerhard Radtke, Davis Polk & Wardwell: The high yield flow has always been very volatile: everybody rushes in or everybody waits. And the drivers have been different over time — macro trends in specific industries, whether cement at one point or natural resources at another, or FX and yield expectations and differentials between onshore and offshore.
But first and foremost, I think supply has been driven by regulatory matters, particularly the ability of issuers in certain industries to access the onshore bond and loan markets. That has had a fundamental impact, shutting down markets for years at certain points in time and constraining supply from entire sectors, if they can borrow cheaply onshore instead of offshore.
Teng, Standard Chartered: We did a debut bond deal late last year for Shandong Ruyi. This is a private company in China, bond rating of B3/B-, with Standard Chartered acting as the sole global co-ordinator. That deal showed how far this market has come. We do have sophisticated, deep-pocket, buy-and-hold investors in our region and when given enough time to do their work properly, subject to the right covenant package, they can support and anchor transactions.
Ho, JPM AM: I think different investors are also at different stages of maturity. There are mature investors who have been in the market for the past 10 or 20 years, but then we have seen in the last five years a few Chinese asset managers coming to Hong Kong, setting up shop, and investing in high yield names in US dollars. They have plenty of liquidity on the book and they are pretty eager to invest that liquidity.
Wilson Li, Car Inc: We are quite different from state-owned enterprises, the government platforms, or the CREs [commercial real estate companies]. They don’t have any issues financing offshore with their credit profiles. If you just look at interest rates, the onshore market is more attractive. If you also consider FX, onshore loans make more sense. When we raise funds, we typically use the majority of proceeds onshore. In the future there is a potential for other needs, such as M&A and global business expansion. But that is not a core use of proceeds at the moment, it would be funded more ad hoc.
|Albert Yau |
So if it is structurally cheap versus its rating that’s super-attractive. We had a lot of these bonds with 12%, 13%, 13.5% coupons sitting on our books until, starting about a year ago, they started getting called away. We did and continue to participate in a lot of refinancings, but I don’t think the sector is structurally cheap any more. All the naysayers now have actually left the sector because shorting Chinese property bonds doesn’t really pay.What that does is force us to see this sector as just market weight, versus being overweight as before in our deployment of capital. Because we look at things from a total return after leverage perspective, the good thing is that since the performance of the bonds has also increased, the return on capital does not necessarily change our decision that much on what to invest in.
But for these high yield bonds that are now priced for perfection any slip-up is going to cause a very severe drop. It doesn’t matter whether you’re in commodities, in property, or in telecoms, that’s the risk you run if your buyer is becoming more levered. I’m also very cognisant of the fact that we are no longer the price setters. There are these China AMCs [asset management companies] that come in and do their own leveraged carry trade; they raise money through dollar bond issues, they buy high yield bonds, they take it to the offshore banks and lever themselves up even more.
Having said that, there are different ways of diversifying away from Chinese real estate, because currently the spread is at 300bp over the typical five year or three year US Treasury level. For this kind of pricing, it’s not difficult to find substitutes. There is tier one paper coming out from strong banks in the region that is already spreading at the 250bp-300bp level. To me a strong bank that has got implicit government support, I feel that the slippage in paying coupons and not having the right capital buffer could be quite minimal.
Yau, CIFI: The rules generally affect the Chinese issuers even when they have a Cayman Islands or Hong Kong structure, and those whose major shareholder is a Chinese national. So they obviously won’t hit companies like Shui On or a couple of other Chinese developers if their major shareholder was clearly an overseas national at the time of establishment.
Sometimes for certain industries it seems easier to get approvals and sometimes it is less so. If you look at the bonds by China real estate issuers this year, most of us are using quotas that were applied for last year. In 2016 it tended to be quite predictable, this year the process tends to be lengthier.
Yau, CIFI: We understand the process is strictly within NDRC. Of course, when the original circular was issued last year they could have been coming from the FX perspective, I think they still are. As for liquidity and servicing offshore debt, generally the NDRC also focuses on the use of proceeds. Last year a lot of the quota approvals were on the basis of refinancing, but this year it seems the approval is based on multiple factors, not just refinancing. Risk-wise, NDRC and, in the case of onshore bonds, CSRC [the China Securities Regulatory Commission] have never actually missed approvals in terms of timing for refinancing need, so we are not too concerned about whether there will be a systematic problem with issuers not being able to get quotas in time for refinancing.
What remains difficult is to move proceeds from onshore to offshore to repay debt, otherwise we would have done that last year, since the liquidity was just so abundant. We could have paid down all the US dollar debt if it could be achieved, but I think in the near term this is not feasible, unfortunately.
Teng, Standard Chartered: When you operate a business in China you are subjected to regulatory uncertainty. To be successful long term you do need a good bank, a good partner bank that is able to be there for you when you need them. A bank that can execute bond deals offshore and onshore, as well as provide balance sheet support.
Sung, Shui On: My sense is that a lot of issuers, Chinese developers or likewise, have credit facilities outside the bond market in the banking system, for example, to get corporate loans to patch up the gaps. I think a significant credit event seems unlikely at this stage because the offshore market is still very liquid. Systematic risk seems unlikely at this stage unless there is a big fallout in the offshore market.
Radtke, Davis Polk & Wardwell: We would like to see the regulatory process become steadier, so as to avoid swings between very constrained supply at one time and then a supply burst at another. That is unfortunately what we saw late last year, when uncertainty as to whether last year’s approvals could be utilised this year meant a rush to market before calendar year end. Then there was relief because it was established that these approvals could be carried forward for some time.
At the moment, NDRC approvals are not so easily forthcoming and the number of issuers affected seems to be quite large — perhaps in the triple digits. Which raises the question, if the current policy decisions result in new approvals, will there be another supply burst? That would be unfortunate for the market. Ideally, we would have a more reliable and more transparent process, in which the decision to access markets was solely based on capital structure optimisation, rather than regulatory cycles.
The SAFE [State Administration of Foreign Exchange] perspective is also important, in particular for onshore issuers, meaning PRC A-share-listed companies or issues that are guaranteed by a PRC parent. SAFE regulates the onshoring of funds, and while this is in technical detail still as complex as Albert explained, there has been significant progress. At least now it is feasible for an onshore issuer to guarantee debt raised by an offshore SPV and then to onshore the funds.
|Fred Teng |
We could be talking about inadequate levels of due diligence, for example. Is the due diligence scope enough for us to put our hand on our heart to say we know this company, we know what we’re selling? When major banks decline to participate, investors should try and find out why.
Radtke, Davis Polk & Wardwell: Due diligence is an important and sensitive topic, but it is always situation and fact-specific. The market has a large continuum from private placements at one end to deals that are widely marketed globally at the other end, and different execution styles are necessary and suitable for that wide spectrum. The important thing is to ensure that all participants in a particular transaction are on the same page.
A very light touch on due diligence may be suitable in a private placement or a marketed club deal, where the investors have a very clear understanding of the issuer, its strategy and its control group. It may be suitable if the investors in that club deal are able to assess that particular issue and issuer. The risk is when those types of light touch executions are all of a sudden applied in deals that are marketed in the more normal way. It is important to adhere to a comprehensive due diligence standard if it is a real marketed deal.
At the same time, we have new bank entrants to this market, and they have grown up in the onshore market and have developed different processes and procedures for how they place bonds onshore. There’s going to be an import of certain methods from onshore bond offerings. We have seen that in the terms of the bonds, where, for example, upsizing options have popped up. We have seen a couple of bonds which had a ‘term plus’ approach, where investors had to put at a certain point of time. Those were features that came originally from the onshore market, and these influences will be a fact of life.
Fung, BFAM Partners: It’s not just on the due diligence side that investors are concerned. Even on the deal execution side there are different standards from international banks to local security houses, on whether everybody gets bonds re-offered at the same price, whether book messages are consistent with standards required by the SFC [Securities and Futures Commission], for example. Obviously some of these rules are up for interpretation, but clearly some very aggressive interpretations are being taken. I think it takes away investors’ confidence, and if you only have those local security houses on a deal, investors will shy away.
Ho, JPM AM: With investors at different maturities in their lifecycles and experiences in this market, one could only self-regulate within the organisation themselves, rather than relying on the association of the asset managers or relying on the club effort of the industry to make this right. Small issues of $200m-$300m can easily be done without the involvement of a certain party. If a certain investor does not agree to the revised terms and conditions of covenants, then they may lose out on receiving the consent fee when the looser revised covenant has been agreed upon.
GlobalCapital: I want to touch on the topic of ratings. The issuers here have different histories in that regard: Albert, there seems to have been some lagging on how your rating has improved over time, given the firm’s growth. Has that hurt your funding costs?
Yau, CIFI: Absolutely. I think if you look at the general ratings by the three international agencies against the CRE space they are consistently lower compared to our international peers. However, on the other side, the market is assigning differentiation to issuers, even though the notching of the rating is not there.
|Douglas Sung |
Teng, Standard Chartered: For CIFI and similarly rated peers, my view is that the rating agencies have lagged the market. If I look at Albert’s case, CIFI has doubled Ebitda in the last couple of years, their funding cost has improved tremendously, coupons have halved. The company’s margins have continued to be very good, but they have only been rewarded with a one notch upgrade during this.
Shui On is unique. Not every unrated company out there will have the ability to access the bond market in the scale that Douglas is able to do. I do think ratings are important, particularly for debut issuers. Generally speaking, only a very recognisable name can pull off issuing unrated bonds. Depending on the size of the issuer’s future funding needs, an issuer may also want to think about how big an investment pool it wants to target, long term. Hong Kong is unique in that there are many issuers with high name recognition, particularly from the real estate sector. Those with established MTN programmes are able to raise small amounts of unrated bonds with no high yield covenants. But there is a size limit to this market.
| Shaw Yann Ho |
JP Morgan Asset
Ho, JPM AM: I think without ratings formally granted by credit rating agencies we’ll be very stringent to price them to the cycle. I think the agencies are behind the curve because they don’t see the issuers on a one year performance basis. They want to see that you can do the same thing repeatedly for the next three years.
So from the benefit of the doubt point of view, I think it’s only advantageous for the issuer to gain that kind of formality. Otherwise, a certain group of investors could use a more stringent valuation when it comes to pricing. And because the market is pricing at an all-time tight, we can afford to be very selective.
Fung, BFAM Partners: We don’t necessarily rely on the ratings to tell us the credit quality of a company. Some people may argue that they’re always conservative but I don’t think that’s necessarily the case. If anything they’re probably always a bit behind the curve, whether it’s on the up-trend or the down-trend. We’ve seen many cases of bonds being priced at much worse levels than where they are rated.
I have also seen a recent trend where refinancing risk has become part of the rating. They’re taking into account technicals that don’t necessarily paint the correct fundamental credit picture. What I do look at is how ratings might ultimately affect the bond performance and pricing. Fred mentioned the amount of leverage that private banks can get, it’s the same with all leveraged parties. Any time you are financing, whether you’re an AMC or a fund, you’re financing with banks. Banks will likely use a public rating if it’s available, so that would affect the amount of leverage and the rate that you get.
GlobalCapital: Gerhard, what’s the state of play on covenants in Asia? How do we compare Asia and Greater China with the developed markets?
Radtke, Davis Polk & Wardwell: The covenant structure for Asia or Greater China has evolved over time. We did a Shui On bond, one of the very first in the HY space here, over 10 years ago, and the covenant package was extremely tight. Everybody was trying to get their arms around the country and, even more so, around the newly developing real estate industry in China. It meant that every individual lever was tightened by a couple of notches.
Since then the market has changed massively. We now have well known, transparent issuers, like Shui On, that have been in the market for over 10 years, and people are familiar with them. On the other hand, the complexity of issuers and their capital structures has also increased, and with it the need for flexibility in covenants. And that means that these days there is no consistent standard any more, there’s really a variety.
It’s a very different thing if you look at a privately held PRC entity doing a debut issue, compared with a very transparent, well known group like Shui On. Then you have other issuers that may be chasing leverage and may be more aggressive. The market will acknowledge that and, while giving them some flexibility, may also make them pay for it to some extent. So you still see elements of tightness, but you also see issuers that get away with lots of flexibility, whether that is to incur additional leverage or to reorganise their structure. For example, some issuers are looking at the ability to relist at least a portion of their business onshore and are trying to build in flexibility for that into their high yield terms. Such structural flexibility requires significant tinkering with the covenants. This would not traditionally have been available to a high yield issuer.
At the same time, you see diversification of certain industry groups, which has led some issuers to push back on the traditional limitation on changes to an issuer’s permitted lines of business. Judging from the press coverage, removing that clause seems to have triggered a reaction from investors, who are asking whether that’s a good idea or whether issuers need to specifically pay for that.
It is usually very difficult to put a price tag on any individual covenant change, but that one has got singled out a little bit. Another interesting question is how to assess whether the issuer will really make use of the flexibility they’ve negotiated for, or whether they just want to remove their constraints, to give them flexibility on the margins. That assessment seems to be as important as the removal of any given covenant itself.
GlobalCapital: Issuers, how are you taking advantage of this changing picture in covenants? What kinds of thing are you getting away with now?
Yau, CIFI: At CIFI we try to follow the market trends and not be too aggressive. In the past five years our covenants generally worked pretty well so we didn’t have to come out for consent request.
There’s no dispute among our China peers that the covenants inherited from the US high yield bonds are unnecessarily complicated. Even on the buy-side you have to think what type of protections they are really offering you. And unlike the US market, where most of the high yield corporates are relying on bond financing, on our side I think we have now less than 50% of our offshore financing coming from bonds.
So when we see there’s a general trend of loosening then we also follow. And while we are always told by the banks if we loosen our covenants beyond a certain extent it will affect the buying interest, we also look at unrated real estate issuers in Hong Kong and Singapore and wonder how an unrated issuer can have a looser covenant than a high yield issuer, and even price at a lower yield. We are always quite puzzled by that. But, of course, this process is more driven by the buyside.
Sung, Shui On: I would tend to agree: ultimately the covenants are driven by market practice. It is very hard for any one specific issuer to push for a very different package, compared to what the market norm is. Maybe you can tweak it, depending on what your needs are, but ultimately it’s really a reflection of demand and what investors are willing to accept and the liquidity condition in the market.
Having said that, we have just finished a consent request exercise a month ago to relax some of the covenants in the older bonds, because the market is very different now, compared to some of our bonds issued in 2013 and 2014. So we did loosen up quite a lot of those older covenants, which gives us more flexibility in cash management.
Nowadays it is all Reg S deals we’re doing, and depending on the name, we can do anywhere from $500m up to $1bn in size. I’m sure if Albert or Douglas needed it, these sizes are available for them in the Reg S market now at a price. It’s very different from five, 10 years ago.
But I also think there was an inherent Asia premium associated with Asian covenants. When you look at the FCCR [fixed charge coverage ratio] test, it is significantly higher than their peers in the US and Europe. Looking forward, there will be convergence, there is a need for that. It really depends on how long term issuers want to manage their capital markets relationships. If you only need to tap $200m or $300m every few years you probably can get away with a lot of things. But if you have a much more complex business structure, particularly when it’s constantly driven by regulatory uncertainty, these covenants, although it is a heavier burden, allow issuers to maintain some following with the club of international investors. It is a balancing act and, although it’s not always easy to have a perfect equilibrium, I think investors could accept looser terms than what we have now.
Second thing, I’m also very positive on the market efficiency. The market is getting more and more efficient to allow differentiation, so the pricing is a lot better for good developers compared to maybe five years ago. This will continue.
I’m also a strong believer that our sector, even though there have been a lot of improvements already, is still re-rating. We see the bond market re-rated steadily and dramatically compared to five years ago and there’s also re-rating in the stockmarket. This will continue, so I am generally very positive.
Radtke, Davis Polk & Wardwell: I would expect further broadening of the market, both in depth and scope, not just with respect to structures and types of issuers but largely driven by the globalisation of Chinese enterprises — which will ultimately increase the need for US dollar funds.
|Paolo Danese |
Ho, JPM AM: We appreciate more competition in the bond market if that’s feasible, giving us more choices. The one thing that stops us from participating in a loan deal compared to a bond deal is because of the daily liquidity issue. If loan deals can offer daily liquidity in the future then perhaps the market will be less one-sided than now.
The other thing is we are subordinated to loan tranches already, so our need to tighten up the terms and conditions of the bond structure is understandable. And I believe this kind of demand is not something that we create unnecessarily but it is just to protect the vested interests of our end-investors.
Fung, BFAM Partners: I expect the offshore bond market will continue to see good performance from China high yield particularly, and the real estate sector as well. It’s very well entrenched in people’s minds that this is a well performing sector. Even in the last couple of weeks, where we’ve seen significant underperformance in non-Chinese high yield, there is still a very strong bid for Chinese high yield. I don’t think that technical will change.
I do think the market will be much more sensitive to single name events versus systemic events that we’ve seen in the past, where the whole Chinese real estate sector cheapens by five, 10 points. Instead of that you’re going to see affected names cheapen by 20-30 points on any significant red flag. That’s the kind of trend we’ve seen and will head towards.
Overall, there’s nothing to really worry about in the broad market except for name selection, especially given how well priced things are. Looking forward, I would also like to see the continued liberalisation of the onshore market, such that it blends in a little bit more with the offshore market. If the ability for offshore creditors to actually have real onshore collateral comes about, I think that will open up a channel and significantly increase offshore participation or the desire to participate in these markets. Right now it’s not feasible, but I think over the coming years that’s probably an area that regulators and issuers are looking into as well.Euromoney and Standard Chartered will be running a series of webinars on debt capital markets. The next will be ‘India states’ finances and borrowings: The other half of the story’ on July 19. Find out more.
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