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Sunday, 19 November 2017

Red flags are waving in China credit

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  • Jonathan Rogers
HNA’s sky-high yield is just one warning sign for offshore investors, says Jonathan Rogers.

Every financial commentator would like to claim they called the top of the market - the moment when everything went nuts; the big ask that investors swallowed whole, only to find themselves nursing the wounds of extreme market excess months later.

Well, ahead of the collapse of Lehman Brothers and the onset of the Global Financial Crisis I can identify some clear markers of early excess, which would eventually burn with pain as the crisis unfolded.

Many of those stress points are well documented, especially around the structured finance world.

The private placement quagmire was also playing its part. In those days it was about offering warrants along with fixed income PPs that carried monstrous rates of return in the 20%s.

I have no idea what happened to those placements, but I suspect some under-the-radar restructuring exercises were rampant on the fixed income portion, while the equity option holders were left whistling in the wind.

FAST FORWARD TO the present day. Just over a week ago, Chinese conglomerate HNA Group raised eyebrows all around when it offered almost 9% - the coupon was 8.875% - for US$300m of debt maturing in one year. I doubt one could imagine more of a red flag in the context of a company which has over US$600m of debt coming due this year and more than US$2bn in 2018.

Or let me rephrase that: we know that the company is in need of funds, but we also know that the loan market is a better source of short-term funding, for companies that can access it.

The usual greedy stuffees from the ranks of the private banking world were there to book the paper, with the familiar 25-cent premium on offer to incentivise private bankers to market the deal to anyone with an eye for an optically beguiling coupon.

I wonder how much the uncertainty around HNA’s future featured in the PB sales pitch, given the group’s US$50bn-plus acquisition binge and tighter regulatory scrutiny.

Stick to the obvious - almost 9% for one-year money ain’t bad at all, if all goes according to plan.

But, even aside from HNA’s own problems, will it? There are some strange potents of market imbalance out there regarding China credit, whether on the mainland or in Hong Kong, which should give punters pause, even though on the face of it everything appears to be tickety-boo.

For example, the ready ability of China’s big distressed debt manager Huarong Asset Management to raise billions of dollars from offshore bonds and loans, such that lenders are full up to the gunnels on lines, strikes me as something of a red flag.

I say this in the context of a dichotomy that neatly sums up the existential nature of China’s capital markets in their current state: on the one hand you have the profound investor exuberance surrounding an IPO for a subsidiary of internet leviathan Tencent, which flew off the shelves at warp speed on its debut; and on the other you have a somewhat painful debt restructuring for Chinese port operator Dandong, small potatoes at just US$150m-equivalent but a significant sign that domestic investors are losing patience with delinquent borrowers.

Admittedly the port operator has not been helped by its location on the border with North Korea - that business model is less than ideal in the current Trump-coloured geopolitical mix. But still, it highlights the issue of China’s debt mountain and the fact that mainland politicians are no longer afraid of allowing a company to fail.

THE FULL-ON lending, the IPO exuberance in Hong Kong, the over-the-top bond coupon, the restructuring: are these simply part and parcel of a thriving capital market, or is something rather out of whack?

I suspect the latter, but much like the “Trump rally” in US stocks, it all appears to be marching to an unstoppable tune. And the tune in China’s case has been carefully orchestrated by the country’s authorities to match some recent symbolic milestones such as the anniversary of the Hong Kong handover and the Chinese Communist Party’s 19th National Congress.

Might that be a variation on the discipline of “buy the rumour sell the fact”? Set-piece Chinese political events are solid as stone, but even they have their sell-by date too when it comes to market psychology.

It will make sense to monitor closely the secondary market performance of the China Literature IPO (the Tencent subsidiary) as well as the bond for HNA. I suspect breathless enthusiasm may well give way to something more prosaic as the milestones in China start to fade into the background.

And I would keep an eye out for Chinese companies which have big redemption bumps in their yield curves; the capital markets may not be this accommodating for long.

 

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