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China’s Hot Convertibles Market on Alert for First Default

Bloomberg News

(Bloomberg) -- Concern that China may soon witness its first convertible-bond default is drawing attention to just how speculative the market has become.The Shenzhen Stock Exchange suspended trading in Jiangsu Huifeng Bio Agriculture Co.’s bond in late April after the company reported its second consecutive year of losses. Jiangsu Huifeng warned in an April 29 exchange filing that it may not be able to pay investors should a large proportion of the notes, set to mature in 2022, fail to convert into equity when they come due. A decision on its listing status is expected no later than May 22.

Adding to the nervousness is a put option that allows investors to demand early repayment on the bond -- a clause that’s triggered if the stock trades below a certain level for 30 consecutive trading days. Thursday was the 15th day.

Jiangsu Huifeng’s plight highlights the growing risks in China’s convertible-bond market, where smaller companies are making the most of high demand to raise funds. New issues are so coveted that bids can exceed supply by hundred or thousands of times. A hunt for returns has pushed up prices in the secondary market, with a few convertible bonds trading at more than three times face value.

“We need to pay attention to whether Huifeng can raise sufficient funds through financing,” said Qi Sheng, analyst at Founder Securities Co. “If it fails to offset the demand from the investor put, it will become the first to default a convertible bond in China.”

After a record 126 convertible bonds were sold in China last year, raising a combined 269 billion yuan ($38 billion), this year’s pace is set to top that with 56 deals so far. Rushing in have been smaller and lower-rated firms, who tend to have increased credit risks. According to data compiled by Bloomberg, 86% of 2020’s total issuers are rated AA or less, the most in at least a decade.

Beyond Jiangsu Huifeng’s default risk, the threat of redemption is also a concern for investors. On Wednesday, a convertible bond issued by TKD Science & Technology Co.’s sank as much as 12% after the firm disclosed the terms of its buyback, which will be at a massive discount to recent trading levels. It had lost as much as 50% last week after first announcing the early repurchase.

Calls to Jiangsu Huifeng and TKD seeking comment went unanswered.

There are 14 companies with convertible bonds that have reached their stated thresholds for redemption this year, analysts at Sinolink Securities said in a research note last week. Nine of the firms haven’t announced plans to redeem, and eight of their convertible notes traded at least double the 100 yuan face value, as of Wednesday. Issues from Hubei Kailong Chemical Group Co. and Shenzhen SDG Information Co. were around 350 yuan.

China’s securities regulator acted to curb activity in the convertible bond market early last year, after an investor stampede into new issues stoked concern that the market was overheating. Officials had relented by the end of 2019, allowing new issuance to pick up.

More recently, exchanges have moved to keep closer tabs on convertible bonds, and the government has expressed some concern. In a commentary, the state-run Securities Times urged investors to improve their risk awareness regarding convertible bonds. They “should not rush forward because of the price hike. Investors should stay away from the minefields and not dance on them.”

“The atmosphere of speculation is so strong that it has made the convertible bond market into a casino, especially for small-sized issues,” said Jiang Liangqing, a fund manager at Beijing-based Ruisen Capital Management. “With the rapid expansion of new issues since last year, more and more people are paying attention to it.”

(Updates stock data in third paragraph, adds issuance data in sixth paragraph)

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