Sub-investment-grade firms have joined the queue to offer high-yield debt paper Asia's 'high-yield' paper looks likely to keep the bond fires burning this year, with sub-investment-grade companies reported to be joining a queue of issuers waiting to come to global capital markets to fund their growth. That's good news for bond investors who have developed a healthy appetite for portfolio-enhancing 8 to 9 per cent coupon interest payments and can expect more to come. It's also good news for borrowers whose access to bank credit may be priced prohibitively or shut (as in the case of mainland companies operating in overheated sectors of the economy). And finally, it's good news for the investment banks that bring sub-investment-grade risks to the market and will be hoping that the higher fees earned from such deals compensate for what could be a drop in big blue-chip issues. Bankers are quick to point out they work considerably hard for their crust, doing due diligence on higher-risk credits, obtaining legal opinions and preparing the offer with often complex covenants designed to ensure its acceptance by investors. But, while fees on regulation blue-chip bond issues have been shaved by intense competition from distributors to about 37 basis points, fees on a high-yield issue may be six times higher - witness the 225 basis points collected by Morgan Stanley for playing solo bookrunner on Asia Aluminum's US$450 million issue, topped by a fee of 250 basis points for its sole underwriting of Sino-Forest's US$300 million issue. Morgan Stanley also had a hand in the only other China high-yield bond to be completed so far - a US$100 million issue by Panvas Gas which it distributed jointly with Merrill Lynch, sharing a fee of 225 basis points. Now, bankers and ratings agencies say there's more of this type of business in the pipeline, with Morgan Stanley's recent dominance in bringing China borrowers to the market likely to be challenged by rivals such as Goldman Sachs. 'Look at 2005 so far and 100 per cent of deals have been below investment grade,' says Goldman's head of leveraged finance, Derek Armstrong. He adds that the bank's ratings advisory group has recently been particularly active around the region preparing to bring prospective sub-investment-grade issuers to the market, and ratings agency Standard & Poor's tells a similar story. Bankers say last year's US$38.4 billion record international bond issuance by Asian borrowers (excluding Japan) is not likely to be matched and, with interest rates on the march, there could be some switching to equity markets for fresh capital raisings. But a larger slice of a prospectively smaller pie this year will be commanded by high-yield issuers, with mainland borrowers expected to provide a core supply of the paper. In this respect, the example of Chaoda Modern Agriculture is instructive. Scrapped in July last year, a born-again issue is back on the road, revised to include a full set of covenants designed to provide investors with some comfort that their cash will not leak out of the company. Typically, such covenants will set limits on total indebtedness, asset sales and dividend distributions. They may also limit the issuance of additional secured debt granting new lenders preferential treatment over existing bondholders. The rules are written, in short, to try to ensure that the bondholders' cash stays in the system and is put to use making profits that can be applied repaying debt. Of course, rules may be broken, and ratings agencies warn that there are accidents waiting to happen scattered about the high-yield debt landscape this year. Further complicating the investment arithmetic for prospective issuers and bondholders is the outlook for benchmark US interest rates, from which international bonds will continue to be priced, along with inflation rates. A larger than expected outcome for either could make nonsense later in the year of what today looks like a winning 8 per cent yield.
