Junk Rally Sparks Sales by Nikko Amid Bubble Risk: China Credit

Nikko Asset Management Ltd. and GAM Holding AG are trimming holdings of Chinese dollar-denominated junk bonds amid their strongest rally in almost a year, concerned over a surge in issuance and a possible asset bubble.

Speculative-grade securities in China gained 3 percent in September, the most since November, beating the 1 percent advance for U.S. counterparts, according to Bank of America Merrill Lynch indexes. Nikko and GAM decreased holdings earlier this month, while Morgan Stanley favors investment-grade Hong Kong-based corporates as leverage among Chinese companies soars.

“We’ve taken profits on some Chinese industrial and property names,” said Leong Wai Hoong, a Singapore-based money manager at Nikko, which oversees about $156 billion. “We still retain an overweight position but with a reduced allocation because of the valuations. I’m concerned about the supply of new issues, and China’s economic outlook.”

A report yesterday showed home prices in China’s four-biggest cities jumped the most since January 2011 last month, sparking speculation Premier Li Keqiang will be forced to impose stricter policies to rein in prices and limit the risk of a market collapse. Although growth in the world’s second-biggest economy has rebounded from two quarters of slowdown, that recovery may have ended as momentum eased in September, Nomura Holdings Inc. said last week.

Rocketing Leverage

Chinese corporates pushed debt to 3.6 times their earnings before interest, tax, depreciation and amortization in the first half of this year, Morgan Stanley said in a note dated Oct. 18. That’s the highest globally and at least 1.5 times more than companies in the U.S, Europe and other emerging markets, according to the report.

A lack of transparency is making GAM wary of some Chinese high-yield names in a market dominated by developers, according to Johannes Wagner, a London-based manager at the investment firm, which manages some $123 billion of assets globally. It sold some high-yield debt “in the past few days” as a tactical move.

“There’s no idea about how they come up with their earnings, where they’re building stuff,” Wagner said in an e-mail interview on Oct. 21. “Bonds sold by banks in Kazakhstan were hugely popular in 2007 but the money went into construction and there wasn’t enough demand for the apartments. So everything went bust.”

‘Downside Vulnerability’

Bonds of Chinese companies make up five of Goldman Sachs Group Inc.’s six least-favored junk notes in Asia, the New York-based investment bank said in an Oct. 16 report. They include Citic Pacific Ltd.’s $1 billion of 8.625 percent perpetual securities, Yanlord Land Group Ltd.’s $300 million of 9.5 percent debentures due 2017 and Soho China Ltd.’s $600 million of 5.75 percent 2017 notes.

Morgan Stanley on Oct. 11 listed some securities issued by Citic Pacific, KWG Property Holding Ltd., Glorious Property Holdings Ltd. and Fosun International Ltd. as having “downside vulnerability.”

Citic Pacific’s 8.625 percent notes, sold at par in May, were trading at 97.708 cents on the dollar to yield 9.897 percent as of 11:15 a.m. in Hong Kong, Bloomberg-compiled prices show. Yanlord Land’s 9.5 percent bonds sold in April 2010 at 100 cents on the dollar yielded 7.277 percent and traded at 106.79 cents.

Record Junk

“The worsening in Asia high-yield fundamentals over the last three years is compounded by the fact bank borrowing conditions are likely to remain unsupportive over the coming quarter,” said Viktor Hjort, a Hong Kong-based managing director in the bank’s research team. “China high yield is an asset class whose performance is always highly sensitive to the ebbs and flows of credit.”

Mainland and Hong Kong-based companies have sold $58.5 billion of dollar bonds so far this year versus $39 billion the same period of 2012, according to data compiled by Bloomberg. Speculative-grade sales total a record $14.3 billion, the data show.

Aluminum Corp. of China Ltd. sold $350 million of variable perpetual notes yesterday while Haitong Securities Co. raised $900 million from a five-year bond offering.

“The new issuance market has reopened and we expect a significant amount of pent-up supply in coming months,” Goldman Sachs analysts led by Hong Kong-based Kenneth Ho said on Oct. 16. This will likely cap any market rally in the region, he said.

Bubble Risk

Chinese high-yield bonds have gained 1.6 percent this month through Oct. 21, matching rallies in similar notes from Brazil, Russia and India, according to Bank of America Merrill Lynch indexes. Indonesian debt returned 3.6 percent, the data show.

Notes rallied as China’s economic outlook improved and the Federal Reserve said it won’t taper stimulus which has buoyed emerging-market assets globally just yet. Economic expansion quickened to 7.8 percent in the third quarter from a year earlier, the statistics bureau said Oct. 18, reversing a slowdown that put the government at risk of missing its growth target for 2013.

New home prices in September rose 20 percent in the southern business hubs of Shenzhen and Guangzhou, 17 percent in Shanghai and 16 percent in Beijing from a year earlier, government data released yesterday show.

“Home prices, especially in big cities, are a bit out of control,” said Liu Li-Gang, a Hong Kong-based economist at Australia & New Zealand Banking Group Ltd. “China’s facing an increasing risk of a property bubble.”

Default Swaps

Five-year credit-default swaps insuring China’s sovereign debt against non-payment have risen 12 basis points this year to 78 on Oct. 22, according to data provider CMA. The yuan, which has gained 2.4 percent against the dollar in 2013, was little changed at 6.0861 per dollar as of 11:20 a.m. in Shanghai. Ten-year government bonds were yielding 4.13 percent on Oct. 22, up from 3.61 percent at the start of the year, Chinabond data show.

Policy makers will cut their 2014 growth target to 7 percent versus this year’s 7.5 percent goal, as fixed-asset investments and sales of floor space weaken, Nomura’s chief China economist Zhang Zhiwei wrote in an Oct. 18 note.

“Our base case scenario is China will continue with reforms to unleash its economic potential and tackle the leverage in the system,” Nikko’s Leong said. “If that doesn’t happen, high-yield notes could struggle.”

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