China Brings Back High-Risk Debt Structures to Increase Leverage

Updated on
  • Chinese companies issue record amount of putable bonds
  • Number of debt guarantee firms in China surges over 8,000

Remember putable bonds? Or debt insurers that collapsed in the U.S. in the wake of the global financial crisis? They’re back -- in China.

Oceanwide Holdings Co. earlier this month sold the largest dollar-denominated putable security from Asia since 2003. Investors can demand the Beijing developer buy the notes back in three years, even if it doesn’t want to. HNA Capital Holding Co., a Beijing-based investment bank, sold $200 million of bonds Aug. 11 guaranteed by a Chinese insurer whose exposure to troubled debt doubled last year.

Amount of putable bonds issued in the U.S. and in China since 2005
Amount of putable bonds issued in the U.S. and in China since 2005

China is reviving high-risk structures common in the run-up to the credit crisis, adding to concern corporate failures may spread after defaults mounted this year amid the slowest economic growth since 1990. The nation’s firms also sold 243 billion yuan ($38 billion) of asset-backed securities this year including two tied to stock margin loans. That’s three times the amount in the U.S. and almost 30 times offerings in Europe.

“History repeats itself in financial markets,” said Ashley Perrott, the head of pan-Asia fixed income at UBS Global Asset Management in Singapore. “When traditional securities these days struggle to give much in returns, the pressure to get yield or enhance returns often pushes investors into things they may not have otherwise touched.”

An operator at Oceanwide Holdings wouldn’t transfer the call. Three calls to HNA Capital Holding went unanswered.

Outlook Lowered

Standard & Poor’s cut its outlook on Oceanwide to negative last month saying the developer may need time to meet ongoing obligations. At the same time, S&P also said that the company’s ability to draw down more than 10 billion yuan in loans in the first half shows "a track record of refinancing its debt and good banking relationships."

Fitch Ratings graded the notes B today.

HNA Group has adequate liquidity and high capacity of repaying debt with sound outside funding channels and good relations with many banks, according to a report last month from Shanghai Brilliance Credit Rating & Investors Service Co.

China’s firms have issued a record $19.4 billion equivalent in the third quarter of putable bonds. Borrowers often use the structure to sweeten offerings for buyers who may otherwise not be interested. That compares with just $178 million in the U.S., the world’s biggest bond market.

“If the issuers aren’t able to repay, they may get into liquidity trouble,”said Hong Kong-based Ivan Chung, a senior director at Moody’s Investors Service. “Weaker credits, they may not be able to refinance it easily.”

Two putable bonds have already defaulted in China in the past year. Cloud Live Technology Group Co. missed payment on such notes in April after Premier Li Keqiang told parliament the previous month he is prepared to tolerate individual cases of “financial risk.” China’s first-ever default, when Shanghai Chaori Solar Energy Science & Technology Co. failed to honor obligations last year, was also on such securities.

U.S. Roots

Bond insurance such as the one offered by China United SME Guarantee Corp. on the HNA Capital note first appeared in the U.S. in 1971, when Ambac Financial Group Inc. sold a policy on notes of the Greater Juneau Borough Medical Arts Building in Alaska. Ambac filed for bankruptcy in November 2010.

China now has more than 8,000 debt guarantee companies. New bonds backed by such firms were worth 56.3 billion yuan last year, 79 percent more than in 2013, according to China Chengxin International Credit Rating Co. Fewer than 50 are rated and China United SME, which supported the dollar bond, is the only one that has an international investment-grade, according to Moody’s.

“There is little public information about the companies which provide guarantees for privately issued bonds,” said Wen Yuqi, an analyst at China Chengxin International.

Sino-Capital Guaranty Trust Co. was barred by regulators in March from insuring debt after it failed to pay defaulted bonds. Earlier in the year, Hebei Financing Investment Holding Group, the second-largest insurer of corporate loans in China, was put under control of another state firm as it struggled to meet rising payments from defaults, people familiar said at the time.

‘Golden Rule’

Three calls each to Sino-Capital Guaranty and Hebei Financing Investment went unanswered.

“The risk they have taken is quite high relative to the premium they get paid,” said Sally Yim, a vice president at Moody’s in Hong Kong.

Chinese companies’ unprecedented sales of asset-backed notes this year top even the U.S. record in 2008.

“We have seen this many times before with structured products not always working out well, but people have short memories,” UBS Global Asset’s Perrott said. “These may turn out well, who knows, but the golden rule remains, if you want to invest in it, make sure you understand it.”

For Related News and Information:
China’s 1st Note Tied to Stock Margin Loans Seen Adding Risk (2)
Bank of China Plans U.S. Expansion, ABS Products During 2015
Ambac Financial Group Files Bankruptcy to Restructure Bond Debt

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— With assistance by Christopher Langner, and Judy Chen

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