HSBC Converts Loan Clients to Enter Junk Top 10

HSBC Holdings Plc is leading the drive to convert companies to bonds from loans in Asia, helping it enter the global top 10 for junk issuance.

Europe’s largest bank managed $5.3 billion of high-yield debt globally in the first quarter, moving up to 10th place after ranking 13th in the previous three full years, data compiled by Bloomberg show. HSBC led junk bond underwriting in Asia, excluding Japan, in 2012 and says 12 of its 19 deals came from commercial bank clients, or 58 percent of the $2.3 billion it managed in dollars, euro or yen. Last week, it handled offerings by Citic Pacific Ltd. and Sunac China Holdings Ltd.

“The next wave of issuers is not conglomerates, but fast-growing, medium-size companies,” Gordon French, HSBC’s head of global markets for Asia Pacific, said in an interview in Hong Kong last month. “Bonds are a complementary and viable source of funding for them, alongside traditional bank debt.”

HSBC is jostling with UBS AG for the top spot in emerging Asia’s high-yield market this year, each with a 12 percent market share, while Citigroup Inc. follows in third with 10 percent and Deutsche Bank AG in fourth with 9 percent. As companies shifted from loans in the region, junk bonds almost tripled to $14.5 billion, rising to 10 percent of the global total from 3 percent. That exceeded the $13.4 billion in regional syndicated loans of all ratings, up 60 percent from a year earlier.

Middle Ground

Demand is being driven by investors seeking higher yields than in the U.S., Europe and Japan, as well as a boom in private banking for Asia’s own millionaires.

While junk bond yields in the region have fallen to 7.08 percent from 9.35 percent a year ago, that’s still higher than the 6.39 percent average for similarly rated debt globally, according to the Bank of America Merrill Lynch indexes.

Investors “have been faced with zero-percent cash and at the same time maybe aren’t comfortable enough with the world outlook to go to equities,” said Ashley Perrott, the Singapore-based head of pan-Asia fixed-income at UBS Global Asset Management, which managed $634 billion at the end of 2012. “High-yield bonds have been that happy middle-ground where yields are still reasonably good, credit fundamentals are pretty OK, and economic fundamentals are still robust within Asia.”

Default Rate

The global speculative-grade default rate is forecast to end this year at 2.7 percent, compared with an average of 4.7 percent since 1983, Moody’s Investors Service said last month.

Sales worldwide of junk bonds, rated below Baa3 by Moody’s and lower than BBB- at Standard & Poor’s, were a record $150 billion last quarter, following an unprecedented $428 billion in all of 2012, Bloomberg data show. In the U.S., sales were $109 billion in the first three months of the year, the second-busiest quarter ever, following $359 billion in 2012, an all-time high.

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased 0.4 basis point to a mid-price of 88.1 basis points as of 12:04 p.m. in New York, according to prices compiled by Bloomberg.

The index typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Rate Swaps

The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.55 basis point to 16 basis points as of 12:04 p.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.

Bonds of New York-based Morgan Stanley are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 5.4 percent of the volume of dealer trades of $1 million or more as of 12:06 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Bright Spot

Arranging credit was a bright spot for HSBC as it posted a drop in profit for 2012, after paying a record penalty for compliance failures. Net income before tax fell 5.6 percent to $20.7 billion, the lender said in March. Investment bank earnings rose 20 percent to $8.5 billion as the credit business’s contribution more than doubled to $779 million.

HSBC ranks No. 12 in underwriting junk bonds in the U.S., up from 14 last year, according to Bloomberg data that excludes self-led deals. It ranks fifth in Europe, underwriting 36 deals totaling $3.7 billion for a 7 percent market share, Bloomberg data show. It has climbed two places from its position at the end of last year, and is up from 16th in 2011.

HSBC improved its rankings in Asia partly by strengthening the links between its commercial bank clients and capital markets teams, according to French.

Among the recent sales HSBC helped manage was a $500 million offering of 6.375 percent, seven-year bonds for Citic Pacific announced on March 27. The Hong Kong-based company, which is building the world’s largest magnetite iron ore mine and is rated Ba1 by Moody’s, posted a 25 percent drop in 2012 profit on lower earnings from its steel business.

The same day the bank also helped Tianjin-based developer Sunac China market $500 million of 9.375 percent dollar bonds due in 2018.

China Cools

The boom in issuance may slow, as investors are seeking the highest yield premium in six months to own Chinese dollar-denominated debt. Societe Generale SA predicts a further widening as the U.S. economy strengthens and China’s cools.

The yield spread over Treasuries for the Chinese notes surged 71 basis points in the first quarter to 367 basis points, the widest since Sept. 27, according to an index compiled by JPMorgan Chase & Co. That ended a five-quarters of narrowing, the longest stretch on record.

“Valuations in Asian high yields are stretched, especially so for Chinese names, considering their outstanding performance from 2012,” said Kim Jin Ha, the Seoul-based head of global fixed-income at Mirae Asset Global Investments Co., which oversees about $55 billion. “The upside potential is limited. We are going to be more selective on Asian names. We are also reducing allocations in areas with weak fundamentals in Latin America and Eastern Europe.”

Cash Flood

A flood of cash into emerging markets seeking higher returns is slowing as economists forecast U.S. 10-year Treasury yields will rise over the next 12 months. The risk of owning bonds in China is rising after Suntech Power Holdings Co. defaulted on a $541 million convertible note on March 15.

Chinese developers have sold dollar debt as authorities stepped up a three-year campaign to avert a property bubble. The State Council called for higher down-payments and interest rates on second-home mortgages in cities with “excessively fast” price gains, according to a March 1 statement.

“One of the tests we face will be a major default or restructuring,” Stephen Williams, HSBC’s head of debt capital markets, Asia Pacific, said in an interview. “The challenge will be to effectively ring-fence any failure and prevent it from undermining the market more broadly.”

Williams said short-term setbacks would be healthy for the market by helping it “price risk more effectively.”

‘Investor Fatigue’

Fixed-income fund flows continued to pivot toward the U.S. and away from European and emerging markets in the week ended March 20, according to data published by Cambridge, Massachusetts-based EPFR Global. U.S. funds took 80 percent of the $3.7 billion in debt inflows, while commitments to developing-nation debt were the second-lowest in 2013.

French said signs of “investor fatigue” in January proved short-lived and that a longer-term trend of growing regional demand wouldn’t be derailed. There were 3.37 million millionaires in the Asia-Pacific region in 2011, more than in North America for the first time, according to a June report by Capgemini SA and RBC Wealth Management.

“Asia’s wealthy are looking beyond equity markets,” said French, who estimates individuals have moved as much as 25 percent of their investments into fixed income from 5 percent previously. “They find the low volatility attractive after the upheaval in stock markets over the past five years, while the aging demographic means people are looking for lower risks, especially in China and Japan.”

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