Dim Sum Investors Lack Protection on 60% of Bonds: China Credit

Asia’s fastest-growing bond market lacks restrictions that stop companies from borrowing to the brink of default.

Dim Sum bond sales quadrupled to 146 billion yuan ($22.9 billion) this year, even as 60 percent of non-financial corporate securities listed on HSBC Holding Plc’s Offshore Renminbi Bond Index contain no leverage limits, according to marketing materials. BYD Co. (1211), the automaker partly owned by Warren Buffett, and a unit of New World Development Co. sold yuan-denominated bonds this year in Hong Kong without debt-to- equity limits typically required for junk bonds. European and U.S. high-yield dollar issuers are increasing constraints, according to Moody’s Investors Service.

“We want comparable protection to what we get in other markets, regardless of the currency, and to date we’re not always seeing that,” said Bryan Collins, a fixed income portfolio manager at FIL Ltd., known as Fidelity Worldwide Investment. “We’re making it very clear that’s what we expect on new issues,” Collins said during an interview at his offices in Hong Kong. Fidelity manages $207.9 billion of assets globally.

Speculation the yuan will strengthen has fueled demand for the Chinese-currency assets in Hong Kong, where international bondholders can buy and sell debt. China’s slowest economic growth in two years last quarter and a 0.4 percent depreciation of the yuan versus the dollar in November may deter investors from buying the securities without protection.

‘Getting Away With Murder’

“A lot of these Dim Sum bonds issuers have been getting away with murder for a while,” Edmund Harriss, a London-based investment director at Guinness Atkinson Asset Management, said in a phone interview. “I’ve been quite entertained reading some of the offerings that have been put in front of us. The structures, the cash flows, and the relationships between the cash flow generating entity and guarantor have been laughably opaque.” Guinness Atkinson manages $542 million of assets.

The yield on Shenzhen, southern China-based BYD’s 1 billion yuan of three-year bonds sold in Hong Kong has surged 12.16 percentage points to 16.7 percent since April, according to SinoPac Securities Corp. prices. BYD said in October that full- year profit may drop as much as 65 percent because of sliding sales of automobiles and solar-energy products.

Paul Lin, a spokesman for BYD, declined to comment on the company’s bond covenants. The notes don’t restrict BYD from taking on more debt, according to an offering circular distributed to investors before the sale.

Negative Pledge

NWS Holdings Ltd., a unit of property company New World Development, sold 1 billion yuan of 2.75 percent bonds in July, according to data compiled by Bloomberg. The three-year notes yielded 4.08 percent today, according to SinoPac prices. The debt was issued by Silvery Castle Ltd., an indirect wholly owned subsidiary of NWS, which guaranteed the sale. Like BYD, the notes don’t curtail future borrowing, according to its offering circular.

“The terms of the bonds were determined based on HSBC’s professional advice in light of market conditions which prevailed at the time of issue,” Clement Chow, a Hong Kong- based senior manager of investor relations at NWS, said in an e- mailed response to questions yesterday. “Similar practice should apply in future.”

Dim Sum bonds resemble investment-grade debt sold in Europe, Alexander Dill, the New York-based head of covenant research at Moody’s, said in a phone interview last month. More than 85 percent of notes have a negative pledge that stops companies from using their assets as security for new deals and a cross default clause that makes the bond immediately due for payment should the company fail to meet other debt obligations, according to the offering circulars seen by Bloomberg.

Fewer Covenants

More than 70 percent also have a change-of-control term that gives investors a put option allowing them to sell the bonds back to the issuer should ownership be adjusted. None of these covenants stops a company from incurring more debt, the documents show.

Yuan debt sold from medium-term note programs has the least covenants, according to the bond prospectuses. BP Plc (BP/) sold 700 million yuan of bonds due September 2014 from its medium-term program in September, according to data compiled by Bloomberg.

BP’s notes, which were priced to yield 1.7 percent, have no negative pledge, no cross-default clause and no change-of- control put, the marketing material shows.

‘Professionals Only’

“These bonds were issued with our standard terms and conditions,” Robert Wine, a London-based spokesman at BP, wrote in an e-mailed response to questions yesterday.

“It’s a professionals only market so it’s very much self- regulated,” William Liu, a Hong-Kong based partner at law firm Linklaters LLP, said in a phone interview yesterday. “The basic assumption is that institutional investors will be able to look after themselves and the underwriters that bring the deal to market will make sure that the documents contain all the material information that professional bond investors expect to receive.”

Ernest Kong, a spokesman for the Securities & Futures Commission, Hong Kong’s watchdog, declined to comment on the regulation of Dim Sum notes sold to institutional investors. Lorraine Chan, a spokeswoman at Hong Kong Exchanges & Clearing Ltd. said companies selling bonds to professional investors don’t need to publicly disclose offering circulars on the exchange.

Unrated Debt

While BP’s notes are rated A by Standard & Poor’s, the sixth-highest investment-grade ranking, more than 71 percent of non-financial corporate Dim Sum bonds in HSBC’s index are unrated or categorized as high-yield by either Moody’s, S&P or Fitch Ratings.

High-yield, high-risk bonds are rated below Baa3 by Moody’s and less than BBB- by S&P, their lowest investment grades.

Junk dollar-denominated bonds typically include leverage restrictions such as a fixed-charge coverage ratio or debt-to- equity ratio that stop a company from borrowing unless it can service the new debt and existing obligations, a report published by Moody’s said last month.

Road King Infrastructure Ltd., Guangzhou R&F Properties Co., Zhongsheng Group Holdings Ltd. and China Shanshui Cement Group Ltd. are the only non-financial companies in the HSBC index offering notes with this level of protection.

High-yield companies in Europe and the U.S. are putting more covenants in their bonds, according to a June report by Moody’s.

Dim Sum Losses

The ratings firm’s so-called Covenant-Lite Bond Index, which comprises 832 speculative-grade bonds sold between January 2008 and the end of April this year, measures how many notes contain less stringent creditor protections. The index fell to 7.1 percent for the first four months of 2011 from a high of 14.7 percent in 2009, indicating that more companies were adding restrictions, the report said.

Dim Sum bonds lost an average 2.03 percent this year, according to HSBC’s indexes. Including currency appreciation, the notes have returned 1.23 percent, the indexes show. The 0.34 percent weakening of the yuan versus the dollar last month meant investors lost 0.74 percent on their Dim Sum bond investments, the indexes show.

“The pipeline is much bigger and investors have many choices of issues, so it’s now a buyers’ market,” Linklaters’ Liu said. “The issuers need to actually demonstrate to the investors why they’re better than the others.”

Companies are starting to promise greater borrowing restrictions to attract more investors, according to Ivan Chung, a Hong Kong-based senior analyst at Moody’s.

Improve Chances

“There are lots of deals in the pipeline that are repackaging themselves,” he said in a phone interview. “Originally they didn’t have many covenants but since market sentiment is not good, they are trying to improve their covenant package in order to improve their chance of selling in the market. Most have not come to the market yet but sooner or later this trend will become more obvious.”

China’s currency advanced 0.19 percent this week to 6.3627 per dollar in Shanghai as of 10:22 a.m., according to the China Foreign Exchange Trade System.

Yields on China’s 10-year bonds fell two basis points, or 0.02 percentage point, to 3.617 percent yesterday, according to Chinabond.

The cost of insuring Chinese sovereign bonds against non- payment has more than doubled this year with five-year credit- default swaps at 138.6 basis points yesterday, according to data provider 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.

To contact the reporter on this story: Rachel Evans in Hong Kong at revans43@bloomberg.net

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

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