Asia Convertible Slump Means Citi Sees 25% Gain: Credit Markets
By Katrina Nicholas
July 5 (Bloomberg) -- The worst quarter for Asian equities in more than a year has pushed yields on convertible bonds higher than some debt that can’t be exchanged for stock, prompting strategists to predict gains of 25 percent or more as the region’s economy posts the fastest growth in the world.
“Upside of 25 percent from here would be a conservative estimate and it could be as much as 50 percent,” Kim Wong, Citigroup Inc.’s head of convertible bond trading for Asia, said in a telephone interview from Hong Kong.
The debt lost 3.92 percent in May and June as measured by Bank of America Merrill Lynch indexes, while the MSCI Asia Pacific Index of stocks fell 10.4 percent. PT Bumi Resources’ $375 million of equity-linked notes due 2014 yield 16 percent, compared with 11.3 percent for its $300 million of bonds due 2016, according to Exane SA and ING Groep NV prices. Shares in Indonesia’s biggest coal producer fell 16.4 percent to 1,880 rupiah (21 cents) in Jakarta this year through June 30.
With the economy in the Asia-Pacific region forecast by Barclays Capital to grow 7.6 percent this year, faster than the 4.7 percent for the world overall, the securities are a bargain, according to Swiss bank Lombard Odier Darier Hentsche & Cie. Some 250 convertible dollar-denominated bonds are outstanding in Asia-Pacific excluding Japan, compared with 3,406 which can’t be exchanged for equity, according to data compiled by Bloomberg.
‘Reward Looks Good’
“If equity markets recover strongly you could make 50 percent, 60 percent” on the debt, Nathalia Barazal, a money manager who invests in equity-linked securities at Lombard Odier, said in a phone interview from Geneva. “If they don’t, you’ve still got a bond with the safety net of a positive yield, so either way the risk versus reward looks good.”
Convertible bonds are notes that can convert to stock at a predetermined ratio. When stocks fall the option to convert loses its value, pushing prices down.
Elsewhere in credit markets, the extra yield investors demand to own corporate bonds rather than government debt rose 2 basis points last week to an average of 197 basis points, or 1.97 percentage points, based on Bank of America Merrill Lynch’s Global Broad Market Corporate Index. The spread has fluctuated between 190 and 201 basis points since May 25 after widening from the low this year of 142 on April 21. Yields ended last week at 3.98 percent, compared with 3.99 percent on June 25.
‘Sobering Reassessment’
Corporate bond sales tumbled last week as credit-default swap indexes jumped. General Motors Co. is seeking a $5 billion revolving line of credit as concern that the economy will slow leads investors to shun loans.
“In the beginning of April it felt like we were off to the races again,” said Tom Newberry, the New York-based head of global leveraged-finance at Credit Suisse Group AG, the fourth- biggest underwriter of leveraged loans this year. There’s since been a “sobering reassessment,” he said.
Companies issued about $9.4 billion of bonds worldwide in the five-day period ended July 2, a drop of 63 percent from the previous week, data compiled by Bloomberg show. That’s the least in five weeks and below this year’s average of $25.3 billion.
Credit-default swaps tied to U.S. corporate bonds jumped the most in six weeks. The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, climbed 8.6 basis points to 122.75 basis points, the biggest weekly rise since the period ended May 21, according to Markit Group Ltd.
Europe Swaps
In London the Markit iTraxx Europe Index of swaps on 125 investment-grade companies rose 0.7 basis point to 127.04. Both indexes typically increase as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of bonds and loans.
GM is talking with banks about setting up a revolving line of credit of $5 billion or more, said two people with knowledge of the plan. The Detroit-based automaker may use the line to pay business costs while using cash to refinance more expensive debt, said one of the people, who asked not to be identified because the talks are private.
GM also wants a credit line to establish relationships with banks, the people said. Noreen Pratscher, a spokeswoman GM, declined to comment.
Loans, Convertibles
The automaker is seeking the loan as prices for the debt weaken. The S&P/LSTA US Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, fell 0.93 cent last week to 87.88 cents on the dollar. The index lost 3.7 percent last quarter after gaining 4.7 percent in the first three months of the year.
Convertible bonds overall have lost 1.48 percent this year after gaining 36.3 percent in 2009 as stocks rallied amid a recovery in the economy. The securities lost 29.3 percent in 2008, Bank of America Merrill Lynch index data show. The firm’s broad corporate bond gauge has gained 5.07 percent following an increase of 16.3 percent in 2009.
Equity-linked securities have been hurt along with stocks amid concern that Europe’s sovereign debt crisis and attempts by governments to reduce spending will slow economic expansion. The MSCI World Index of stocks has tumbled 11.45 percent in 2010.
The average yield on equity-linked bonds from Europe, the Middle East and Africa has “almost doubled” since January, providing new opportunities for investors, said Barclays Capital equity-linked analyst Angus Allison, citing the London-based bank’s EMEA Convertibles index.
Asia Recovery
Asian convertibles may be more attractive than those of Europe and the U.S. because the region’s relative economic strength should translate into a faster equity market recovery, according to Barazal at Lombard Odier, which has 3 billion euros ($3.7 billion) invested globally in the debt.
“If it’s growth, budget deficits, whatever you’re looking at in Europe, Asia looks better,” Barazal said. “We’re overweight Asia because the fundamentals are good.”
PT Berlian Laju Tanker’s $125 million of 2015 convertible bonds yield 28.2 percent, compared with 19.7 percent for its $400 million of non-convertible bonds due 2014, according to Mizuho Securities Co. and BNP Paribas SA prices.
SM Investment Corp., the Philippines company which owns the country’s largest bank by assets and its biggest shopping mall operator, has $300 million of 2012 convertible bonds yielding 4.4 percent, Nomura prices show. Its $350 million of 2013 bonds which aren’t convertible yield 4.1 percent, BNP prices show.
Concentration Risk
Infratil Ltd., the New Zealand investor in energy and transport companies, has NZ$77.3 million ($53.2 million) of 2012 convertible bonds yielding 10.2 percent, New Zealand Exchange Ltd. prices show. Its NZ$20 million of 2011 notes which aren’t convertible yield 7.9 percent.
The size of Asia’s convertible bond market means volatility is higher than in other parts of the world, according to James Simmons, a money manager at hedge fund Enhanced Investment Products Ltd. The firm doesn’t own any equity-linked notes.
“The vast majority of the market is concentrated in the hands of a small number of people, all of whom act at the same time,” he said in a phone interview from Hong Kong. “I’m not saying equities won’t go up or credit spreads won’t tighten, just that I think you’re not being paid enough to take on that kind of additional risk right now.”
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