Asia’s rich must exit crowded trades, cut leverage

By Andy Mukherjee

While equity markets were braving a cold, bleak Tuesday morning meltdown in Hong Kong, the bond market was basking in sunshine — or at least trying to keep itself warm in the not-so-bright glow of Sunshine 100 China Holdings Ltd.'s $165 million dollar bonds.

Amid the carnage, and with Goldman Sachs Group Inc. warning of more pain ahead, the stressed Chinese builder, rated CCC+ by S&P Global Ratings, got away with paying just 8.5 percent, less than the 9.2 percent yield on its existing $235 million notes.

The older securities were issued in September, when Libor was at 1.3 percent. Now the benchmark for global borrowing costs is 1.8 percent. Investors' candles are burning at both ends: their funding costs are rising, and simultaneously, their compensation is falling.

No doubt the Chinese securities firms that scooped up the bond offer will push it toward private-banking clients. Asia's rich are often tempted to use leverage to soup up returns. But can the wealthy really continue to feast on crumbs?

It would be unwise. "Now's a good time to cut leverage," says Michael Levin, head of asset management for Asia-Pacific at Credit Suisse Group AG.

Thanks to a deluge of liquidity, credit spreads on high-yield bonds have gotten super-tight. There are safer alternatives, such as senior secured bank loans by identically or similarly rated issuers, which, according to Levin, provide reasonably high yields, and may be a good asset class to weather the current storm in equities.

That's especially the case if the trigger for this week's equity-market correction is indeed the fear of inflation returning (along with higher interest rates).

In a rising interest rate environment, it makes little sense to magnify the miserly yields of junk bonds using risky leverage. Seeking safety in investment-grade notes may not be such a great idea, either.

Consider 12-month periods ending in December 1994, December 1999, May 2004 and June 2006. In each case, 10-year U.S. treasury yields jumped by more than 1 percentage point. Investment-grade bonds lost money each time, while senior loans rose. The most that PowerShares Senior Loan Portfolio, an exchange-traded fund, has lost in any year since its inception in March 2011 is 0.73 percent.


Overall, the Credit Suisse Leveraged Loan Index, which goes back to 1992, has only had two down years: A 29 percent drop in 2008 was followed by a 45 percent jump in 2009, while the slide of less than half a percent in 2015 was erased by a 10 percent gain in 2016. The gauge closed 4 percent higher last year.

About $1.5 trillion in dollar-denominated leveraged loans were issued in 2017, a 50 percent increase as companies rushed to lock in low financing costs. So far this year, issuance is down 67 percent. But because these loans are contracted on floating rates, there's a reasonable amount of juice here for yield-hunting investors.

The brave among the rich might continue nibbling into red-hot high-yield offerings, hoping they don't get burned. But frankly, the likes of Sunshine are paying too little; so don't rule out a cooling of investor ardor for Chinese developers.

This week's equities gyrations may or may not last, but they're definitely a wake-up call for those at Asia's junk bond party. Even the wealthy can't afford to hit snooze and make like nothing has changed.

(This column does not necessarily reflect the opinion of Bloomberg LP and its owners)

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