January 04, 2013
In late 2012, Latham & Watkins along with ASIFMA, the Financial Times and Bloomberg sponsored a conference in Hong Kong focusing on high yield bonds in Asia. This lw.com Q&A with Latham partner Bryant Edwards looks at the state of the high yield market in Asia and opportunities for growth.
How would you characterize the current state of the high yield market in Asia?
Edwards: The market has grown steadily over the years in Asia, with US$39 billion in high yield bonds issued in 2011. But if you look at it, the Asia market is a small percentage of the overall global high yield market. For example in 2011, the United States issued US$190 billion and the European markets issued US$98 billion.
Why is the market underweight?
Edwards: If you look at it on a GDP basis, the Asia high yield market is underweight — it ought to be much bigger. If the Asia high yield market was as developed as in the United States, you’d have 9 or 10 times as many high yield deals in this market. Just think what it would mean for the various Asian economies to have that much more private capital funding the most exciting Asian companies.
Who are the top performers in Asia?
Edwards: During the last three years, China has led the Rule 144A Asia high yield market, followed by Indonesia. Two things about Chinese high yield jump out at you. One is the huge concentration of the Chinese high yield into the real estate development sector — 80-85 percent of the deals over the last three years have been in this one sector. This is primarily because as a policy matter Chinese real estate companies have not had access to the below market rate loans provided by Chinese state-owned bank lenders.
The other is a structural issue. Almost all international dollar-based Chinese high yield is structurally subordinated. It’s done on an off-shore basis with off-shore issuers who have absolutely no upstream credit support from the on-shore assets supporting the businesses. As a result, Chinese high yield is essentially holding company paper — really equity in the business from a credit perspective.
Have we seen this before?
Edwards: This is eerily familiar to those of us who were in Europe in the early 2000s. The first generation of European high yield was also focused in one sector — the build out of the cable and telecom sector across Europe. When the telecom and cable companies crashed in 2001-2002, the European cable operators had an 80 percent default rate on their high yield bonds and the European telecom operators had a 50 percent default rate on their high yield bonds. Investors in European high yield bonds suffered tremendous losses.
While the US telecom and cable companies went through a similar downturn, US high yield investors fared much better for two reasons. First, US investors received much better recoveries because US high yield bonds were not structurally subordinated. Second, US investors were much better diversified across industry sectors because the US high yield market was widely diversified.
This wipeout in European bonds led to a number of reforms — most importantly an improvement in the structure, with European high yield bonds gaining upstream credit support from the operating assets. Since the reforms, the European market has thrived.
Will China change the rules?
Edwards: Right now, there is a wall of money that wants to get into China, which in spite of a slowdown, has a growth rate that’s still the envy of the world. There also is a lot of interest in investing in renminbi-denominated assets because some investors have a higher level of confidence in the long-term value of the Chinese currency than in the US dollar or the Euro.
Can China rely on its banks to fund future growth?
Edwards: In 2008, China announced a four-trillion yuan stimulus package — primarily through the Chinese banks — to combat the financial crisis. As it turned out, in 2009 and 2010 Chinese banks actually lent 17.5 trillion yuan — mostly to SOEs of local governments.
Analysts who are looking at this are worried that there is a lot of bad debt, that the Chinese banks are over extended and they have a lot of workout problems facing them. Their ability to lend and to continue to finance the growth of Chinese companies is being put into question.
So on the one hand, you have this wall of money and on the other you’ve got Chinese banks that are no longer in the same position to lend and to finance. You’ve got all of the elements for a policy breakthrough that would open up China and allow outside money to come in.