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Who Cares What JPMorgan Says About Junk Bonds?

Shuli Ren
·3 min read

(Bloomberg Opinion) -- Amid hopes of a Covid-19 vaccine, reflation trades are in, as investors sink their money into riskier assets. Junk bond yields in the U.S. were pushed to record lows this week. But that enthusiasm hasn’t spilled over to Asia.

Wall Street’s biggest banks are chiming in. Goldman Sachs Asset Management sees “attractive” returns for Asia’s high-yield dollar bonds, which are dominated by Chinese issuers. JPMorgan Chase & Co concurs. In a recent report, the bank noted that the default rate currently priced in, at roughly 7%, “looks excessive” because the actual figure remains at a well-behaved 2.7% this year.

Are we seeing free money on the table, or do traders know something big banks don’t?

Sure, the default rate may not have been skyrocketing, despite Covid. That's largely thanks to a ballooning number of new issues. But what about the recovery rate, or how much you can expect to claw back if a company fails to pay on time? In its pricing model, JPMorgan made the key assumption of a 40% rate, based on the average over the last five years. This is too simplistic.

Consider China, where the bank sees 78% of Asia’s defaults next year. A five-year average says nothing about the future, because this figure has been falling off a cliff. The recovery rate went from 83% in 2014, when defaults first started to appear, to just 31% three years later, data provided by Ping An Securities Co. show. It was even lower in 2018 and 2019 when money was tight, amid the trade war and Beijing’s deleveraging campaign.

Even within the same year, recovery rates can vary wildly, from just 20% to 100%. There’s not much of a discernible pattern, either. For instance, while court-led settlements are often associated with poor repayments, there are exceptions: Shandong-based industrial conglomerate Xiwang Group Co., a large default last year, proposed to repay its investors in full.

The only practical observation Moody’s Investors Service can offer is that faster settlement is correlated with higher recovery. Most defaulted bonds that have been repaid in full were done so quickly. Xiwang spent 175 days on its settlement, much speedier than the 400-day average. So good luck getting a penny back if you’ve invested in a company that skipped a payment three years ago. Of all the bond defaults between 2014 and May 2020, fewer than 10% have made progress on a settlement.

Moody’s — and some credit managers — have tried to use a bond’s trading price one month after default as a proxy for recovery levels, trusting that distressed debt traders have done their homework. Unfortunately, this doesn’t work in China. Of the 403 defaulted bonds, only 23 had pricing data after missing payments, data compiled by Cinda Securities Co. show. China’s securities regulator didn’t introduce a secondary market for distressed bonds until May 2019.

In other words, low default rates can be terrible news. Few defaults means fewer settlement cases to study. And with so little clarity on recovery, junk bonds in Asia have to remain what they are — high-yield. The spread over their U.S. counterparts is not excessive.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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