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September Losers Now Best Junk Bonds as Housing Debt Rallies: China Credit

Junk-rated dollar-denominated bonds sold by Chinese companies, the world’s worst performers in September, are generating the highest returns this month as investors bet the nation will weather global economic turmoil.

High-yield bonds, primarily issued by the nation’s real estate companies, gained 15.6 percent in October, after losing 20.5 percent last month, according to Bank of America Merrill Lynch data. That compares with 10 percent returns on similar bonds in India and 2.6 percent in the U.S., the data show. Franshion Properties China Ltd. (817)’s dollar bonds rose the most, with a 32 percent increase while Guangdong-based developer Country Garden Holdings Co. (2007)’s debt gained 17 percent.

Chinese bonds are surging along with debt in other Asian markets as speculation increases that European leaders will stem a debt crisis that began in Greece in 2009 and the U.S. will avoid entering a recession. China’s economy grew 9.1 percent in the three months to Sept. 30 from a year earlier, the ninth consecutive quarterly rise of more than 9 percent, according to statistics bureau data.

“While I don’t think the U.S. and Europe can resolve their issues in the next few months, China will be doing fine in terms of its economy and policy,” Steve Wang, the Hong Kong-based head of fixed income research at BOCI Securities, a unit of Bank of China Ltd. said yesterday. “We hit the panic button again and the bonds sold rather quickly. I don’t think it will go back to the worst-case scenario we witnessed in 2008 and if it does it’s another buying opportunity.”

Lending Curbed

Chinese property companies access to credit tightened after a two-year lending boom on concern new home price increases will stoke inflation in the world’s second-largest economy. Policy makers have curbed lending, while limiting house purchases and mortgages.

The finances of most of the major Chinese property developers are better now than in 2008 and the government’s monetary tightening policy may be at its peak, BOCI Securities’ Wang said in an Oct. 18 report. “We remain convinced the Chinese property bonds continue to offer one of the best values in the global high-yield space,” he wrote.

Junk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

Relative yields on dollar-denominated debt sold by Chinese companies are poised for their biggest monthly drop in more than two years and the most among BRIC nations, JPMorgan Chase & Co. indexes show.

European Summit

Chinese bonds yield an average 685 basis points more than U.S. Treasuries, down 161 basis points, or 1.61 percentage point, this month, the data show. Yield premiums on dollar-denominated debt sold by Russian companies declined 124 basis points to 519, while spreads on Indian and Brazilian bonds narrowed 81 and 60, JPMorgan indexes show.

Europe’s leaders will meet in Brussels on Oct. 23 to determine a recapitalization plan for the region’s lenders. Banks are charging each other more for short-term loans, in part because of concern that borrowers will face further writedowns on sovereign debt from Greece and other southern European nations.

The three-month London interbank offered rate for dollars, or Libor, rose to a 14-month high of 0.41167 percent yesterday, data on the most widely used measure of bank lending costs from the British Bankers Association show.

“There’s nothing fundamental about what’s going on in this, it’s just all seat of the pants, panic, fear and greed,” Anthony Michael, Aberdeen’s regional head of fixed income, said in an interview in Hong Kong yesterday. “In the pointy end of the credit markets and Asian high yield market, it’s all about market sentiment.”

‘Selective Easing’

China may undertake targeted measures to support growth as the situation in Europe clouds the outlook for exports and small companies complain of a funding squeeze. The central bank will keep rates on hold for the rest of the year, while “selective easing” may include ensuring funding for small and medium-sized companies and a government housing program, according to JPMorgan.

The People’s Bank of China has injected cash into the financial system every week for the past three months to help ease the cash shortage, pumping in a total 565 billion yuan ($89 billion). The seven-day repurchase rate, a gauge of interbank funding availability, tumbled 154 basis points this month to 3.47 percent, according to a daily fixing published by the National Interbank Funding Center.

‘Severe’ Challenges

The central bank hasn’t raised interest rates since an increase in July took benchmark one-year borrowing costs to 6.56 percent. Policy makers have also boosted the amount lenders must keep in reserve on nine occasions in the past year to help tame inflation.

Consumer prices climbed 6.1 percent in September from a year earlier, exceeding the government’s full-year target of 4 percent. Exports from China rose 17.1 percent in September from a year ago, the least in seven months, customs bureau data released on Oct. 13 showed. The bureau warned of “severe” challenges as the global economic outlook deteriorates.

Relative yields on local-currency corporate bonds are also dropping after reaching a record last week. The premium that top-rated issuers pay over government debt to borrow for 10 years has narrowed nine basis points from 236 basis points on Oct. 11, according to Chinabond data going back to March 2006.

Yields on 10-year Chinese government bonds have slipped from a three-year high of 4.13 percent reached on Aug. 30 and were at 3.74 percent on Oct. 18. The yuan gained 0.06 percent to close at 6.3775 per dollar yesterday in Shanghai, according to the China Foreign Exchange Trade System.

Default Swaps

Five-year credit-default swaps on China’s sovereign bonds have fallen 58 basis points from a more-than two-year high of 201 basis points on Oct. 3, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Investors from Deutsche Bank AG to BlackRock Inc. are accelerating purchases of junk bonds as relative yields decline at the fastest pace this year. Spreads have dropped 2.9 percent this month, the most since September 2010, according to Bank of America Merrill Lynch’s U.S. High Yield Master II Index.

BlackRock, the world’s biggest money manager, is buying speculative-grade bonds as the chance of a severe U.S. economic slowdown wanes, Rick Rieder, chief investment officer of fundamental fixed income at the firm in New York, said in a Bloomberg Television interview on Oct. 13. Deutsche Bank is also moving into high-yield fixed income and away from the highest- rated corporate debt, Kevin Lecocq, the head of global investment solutions at Deutsche Bank’s private wealth management unit said on Oct. 13 on Bloomberg TV.

“The rally in global risk assets makes the relative pricing for most assets appear more attractive,” Viktor Hjort, the Asia head of fixed income research Morgan Stanley, said in a phone interview from Hong Kong yesterday. “I would say calling China’s high-yield property bonds now the most challenging it’s been in over a year as valuations are in no-man’s land.”

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net

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