Bottom-up research pays off when it comes to assessing distressed debt

China-fuelled bond market boom has increased the number of risky borrowers, putting a premium on local knowledge when rating debt

PUBLISHED : Thursday, 31 July, 2014, 1:24am
UPDATED : Thursday, 31 July, 2014, 5:15am

In China's expanding apartment market, Sandra Chow and Cheong Yin Chin have figured out one way to tell whether properties are occupied: drive by and see if people are actually hanging their laundry outside.

Such on-the-ground research helped the two-woman Asian high-yield and distressed debt team at CreditSights decide to upgrade US$3.35 billion of developer Country Garden Holdings' dollar-denominated bonds on March 24, believing the sell-off triggered by the collapse earlier that month of Zhejiang Xingrun Real Estate was too extreme. Since then, Country Garden's debt has rallied as much as 9.1 per cent.

Getting it right when it comes to the region's riskiest borrowers has never been more important. Asia's corporate junk bond market has grown to US$87.2 billion as of the end of last year from US$15.2 billion in 2008, data from Schroder Investment Management showed. Borrowers in China are selling record amounts of notes and some are starting to miss payments. Indonesia's Bakrie group is seeking to avert a third default in 17 months while Australia's Qantas Airways lost its investment-grade rating.

"The hunger for yield means bottom-up research is even more important for money managers so they can discern good credit from bad," said Cheong, who joined CreditSights in December 2012.

Junk-rated notes in Asia returned 5.8 per cent in the first half, according to Bank of America Merrill Lynch indices. Within that, BB1 to B3-rated credits returned 2.3 per cent to 8.9 per cent while those deemed distressed at CC to C fell as much as 20 per cent. BB1 in the US bank's composite grading is equivalent to Ba1 at Moody's Investors Service and BB-plus at Standard & Poor's.

Asian borrowers including China Forestry Holdings, Bakrie Telecom, Suntech Power Holdings and Suzlon Energy have defaulted on at least US$2 billion of US dollar bonds over the past three years. That puts a premium on local knowledge, good access to management and a dose of scepticism, Chow said.

Since overtaking Japan as the world's second-largest economy in 2010, China has helped fuel a bond-market boom. Of the US$116.7 billion of dollar bonds sold in Asia excluding Japan since the end of December, US$63.7 billion have been from companies in Hong Kong and China. Chinese corporate debt surpassed that of the US for the first time in 2013, S&P said on June 15.

With that borrowing comes risk. Although the 7.4 per cent growth economists forecast for China this year outstrips the US' 1.7 per cent, it is the weakest since 1990 and down from as high as 14.2 per cent in 2007.

Slowing growth has led to the first onshore default - Shanghai Chaori Solar Energy Science & Technology missed a bond coupon payment in March - and the collapse of property and building-materials companies including Shanxi Zhenfu Energy Group and Xuzhou Zhongsen Tonghao New Board.


CreditSights, based in New York, was founded by former Deutsche Bank analysts in 2000 and has grown to more than 110 employees worldwide, according to its website. As a research firm that does not underwrite securities or manage assets, it trawls the accounts of more than 850 publicly traded companies and has some 950 institutional clients across the US, Europe, Middle East, Asia and Australia.

Chow and Cheong keep an eye on about 30 non-financial companies in Asia, ranging from those ranked just below investment grade to those who cannot repay their debt.

The team has had its share of misses. Chinese coal miner Hidili's US$380 million of 2015 notes have jumped 11 per cent since the analysts downgraded them to underperform on April 2 amid a refinancing crunch.

Meanwhile, Chinese property developers face a record surge in maturing debt next year as the country's banking regulator says it is monitoring risks from the cooling real estate market.

Home sales in China slid 10.2 per cent by value in the first five months of the year and would-be buyers are being offered deposit-free purchases to clear stock. A survey of 28,000 households in 29 provinces indicated 22 per cent of urban dwellings were empty in 2013, said Gan Li, a director of the Survey & Research Centre for China Household Finance.

"I expect the property sector to face some headwinds, but not wild swings, this year," said Cheong, who spent a week visiting developers and touring their projects in late June. "One has to be vigilant about monitoring the high-yield names there because they could have sizeable impact on the Asian market."