Kaisa Scare Spreads to Top-Rated Chinese Borrowers

The surge in borrowing costs for Chinese junk bond issuers is spreading to investment-grade companies amid the nation’s corruption campaign and following missed payments by Kaisa Group Holdings Ltd.

The average spread at issuance on dollar-denominated notes from China sold since Jan. 1 with investment-grade ratings has leapt to 259 basis points from 207 in the second half of last year, data compiled by Bloomberg show. Corporate securities from China in the U.S. currency have lost 0.45 percent this year. Only debt from Bangladesh, Mongolia and Sri Lankan companies has lost more among emerging Asian countries, JPMorgan Chase & Co. indexes showed.

Concerns are mounting that even China’s best-rated companies may get caught up in government probes as President Xi Jinping targets both “tigers and flies” in his anti-graft drive. In the highest profile cases, at least seven officials have been removed at China National Petroleum Corp. including the former chairman Zhou Yongkang, a previous member of the party’s Politburo Standing Committee in charge of domestic security.

“The China premium used to be close to nothing when compared to the developed names globally,” Raymond Chia, head of credit research in Asia ex-Japan for Schroder Investment Management Ltd., which controls about $450 billion, said in a Jan. 22 e-mail. “But now, with the corruption clampdown which makes the government the locksmith, as well as the commodity price impact, investors are having a more careful look at Chinese names.”

Sovereign Risk

Kaisa is being investigated by the government for dealings with official Jiang Zunyu, who’s been under a probe since October, people familiar with the matter said Jan. 13. Jiang had served as party chief of Shenzhen’s Longgang district, where some approval procedures for Kaisa projects were suspended last month.

The builder failed to make an interest payment due Jan. 8 on $500 million of 10.25 percent dollar bonds before getting a waiver on a HK$400 million ($52 million) loan from HSBC Holdings Plc. The notes slid 40 percent last month as some projects were blocked and founder Kwok Ying Shing quit, reaching a low of 29.9 cents on the dollar Jan. 7. Speculative grade Chinese notes fell 3.9 percent this year, a Bank of America Merrill Lynch index shows.

Investors Scramble

“The recent spate of events has sparked a scramble by investors to reassess the dynamics of pricing in political and event risks in China,” Lee Chok Wai, a credit analyst in Singapore at Oversea-Chinese Banking Corp., wrote in a Jan. 21 report. “The key question at this juncture is whether what was initially viewed as idiosyncratic event risk has now become systemic.”

The cost of protecting against a default of the Chinese government touched the highest in nine months on Jan. 19 and was still at 89 basis points Thursday, a level almost 50 percent higher than that paid to hedge South Korean risk, according to credit default swap prices. China has an AA- rating from Standard & Poor’s, one notch higher than Korea.

“Our main concern now is not knowing which corporates could be next in the Chinese government’s cross-hairs,” Brigitte Posch, the London-based head of emerging market corporate debt at Babson Capital Management LLC, said in a Jan. 9 e-mail. “The political risk element is no longer to be relegated to background noise at a macro level.”

Overseas Bondholders

Foreign investors face the possibility of steep losses because Chinese courts don’t recognize judgments obtained in foreign courts, although exceptions may be made for Turkey and Italy where the governments have mutual treaties, according to Hong Kong-based restructuring advisers Mayer Brown JSM.

“President Xi’s call for greater transparency and rule of law in China continues to be a work in progress,” said Suanjin Tan, portfolio manager in the Asia fixed-income team at BlackRock Inc. “Investors would do well to pay heed to this when looking to invest into Chinese companies.”

The Shenzhen government is holding talks with several property developers in a bid to orchestrate investments in Kaisa, people familiar with the matter said Thursday. The government doesn’t want stakes to be sold at a discount, one of the people said, asking not to be identified because the discussions are private.

An official from Shenzhen city government’s press office said they don’t have information regarding this matter. An officer from Kaisa’s public relations department declined to comment when reached by telephone Thursday.

Rebound Questioned

About 1,000 homes and retail property of two projects related to Kaisa have been sealed in the southern Chinese city of Guangzhou, according to Bloomberg calculations based on data from the website managed by Guangzhou’s housing regulator.

Any stake sale may not help foreign investors in Kaisa, Charles Macgregor, head of Asia high-yield research at Lucror Analytics, wrote in a note Friday. While the price of Kaisa’s 2020 bonds jumped 8.4 cents on the dollar Thursday after the Bloomberg report on the developer talks and were up another 7.6 cents at 51.4 as of 5:13 p.m. today in Hong Kong, caution is needed, Macgregor said.

“We are somewhat bemused that bond investors seem so buoyant,” he said. “We do not believe this would materially improve returns for dollar noteholders.”

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