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2024-08-02

Convertible Bonds Plunge: 83 Below Par, Rating Downgrades Loom

On the last trading day of the first half of 2024, the convertible bond market, which had experienced a sudden sharp decline, ended the day in the red. Despite the "stampede-style" plummet over four consecutive trading days from June 19th to June 24th, the convertible bond market has seen a rebound since this Tuesday (June 25th). As of the close on June 28th, the China Convertible Bond Index rose by 0.36%, with a cumulative increase of 0.46% for the week; the performance of the Convertible Bond ETF Index was similar, closing up by 0.19% today.

The reporter noticed that after this "V-shaped" market movement, there are still many individual bonds trading below their par value. As of the close on the 28th, 83 convertible bonds were still below 100 yuan, and 14 were in the range of 100 yuan to 101 yuan, on the verge of breaking the hundred-yuan par value line. Moreover, most of the above-mentioned low-priced individual bonds are in low credit ratings.

In the view of industry insiders, although the convertible bond market is gradually becoming more rational, this round of "stampede-style" market movement indicates that credit risk is impacting the market. The expectation of a "floor" for convertible bonds has been completely shattered, and investors need to adapt to the new adjustments in the capital market.

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There are still 83 bonds trading below par value. After four consecutive trading days of sharp declines, the convertible bond market this week has seen a bottoming rebound. The China Convertible Bond Index fell by 0.45%, 1.01%, 0.58%, and 1.42% respectively from June 19th to June 24th. After four consecutive days of decline, the convertible bond market started to rebound. As of the close on June 28th, the China Convertible Bond Index rose by 0.36%, with a cumulative increase of 0.46% for the week; the performance of the Convertible Bond ETF Index was similar, closing up by 0.19% today, with a significant gain of 1.27% on the 26th.

Driven by the rebound market, the individual bonds that were significantly "downward" in the early period also rebounded, with many even hitting the upper limit. For example, Lingnan Convertible Bond has hit the 20% upper limit for two consecutive days on the 25th and 26th, with the price rising from 51.27 yuan at the close on the 24th to 75.90 yuan at the close on the 28th. Guanghui Convertible Bond has experienced significant fluctuations during the rebound, despite hitting the upper limit on the 26th, it fell by 16.50% on the 25th, and closed up by 4.74% and 11.82% on the 27th and 28th, respectively. The price of this individual bond has risen from 62.2 yuan at the close on the 24th to the latest closing price of 52.08 yuan.

"The risk of delisting in the early period fermented, and the market appeared to have disorderly pricing for low-priced convertible bonds, which is an irrational behavior," a convertible bond market trader told the reporter. The consecutive rebounds of convertible bonds in recent days are, on the one hand, a return to value after the sharp price adjustment in the early period, and on the other hand, it is also not ruled out that there is speculation.

Although the number of nearly hundred convertible bonds that were close to breaking the hundred-yuan par value line has decreased under the drive of the rebound market, as of the close on the 28th, there are still 83 individual bonds trading below 100 yuan, which is 13 less than the 96 on the 25th, but this number was only 31 last month; another 14 are in the range of 100 yuan to 101 yuan, on the verge of breaking the hundred-yuan par value line.The reporter also observed that in this round of rebound, the market's concentrated willingness to buy back the aforementioned low-priced bonds was prominently reflected on the 25th and 26th, with the 26th being more evident. Among the top 20 bonds with the highest gains that day, 18 were low-priced bonds, accounting for 90%; the following day, this number dropped to 8, with the proportion slipping to 40%.

Further examination reveals that the bonds that broke through the face value line of 100 yuan were concentrated in industries such as architectural decoration, power equipment, and basic chemical industries. Convertible bonds rated AAA and below have generally adjusted, with a characteristic that the lower the rating, the greater the decline. Statistically, from May 31 to June 20, AAA-rated convertible bonds only fell by 0.08%, outperforming the CSI Convertible Bond Index by 2.48 percentage points; whereas those rated below AAA generally adjusted, with AA+, AA, and AA- and below convertible bond indices underperforming the CSI Convertible Bond Index by 0.77 percentage points, 3.65 percentage points, and 5.27 percentage points, respectively.

In response to the situation where many convertible bonds still break through the 100 yuan face value, several market insiders analyzed to the reporter that many issuers of convertible bonds show signs of declining profitability, their ability to repay is questioned, and many companies face the risk of delisting, which is difficult to reverse in the short term; "If there are no subsequent bearish factors about the delisting of the underlying stock, more convertible bonds may continue to rebound in the future."

Credit risk continues to be exposed.

Although there is a market view that the short-term bearish factors for low-priced bonds will eventually pass, and prices that deviate significantly from the reasonable range will rebound, many institutional insiders told Yicai that credit risk is still disturbing the convertible bond market.

In the past, convertible bond varieties were based on the "floor guarantee" as the benchmark, and investors did not need to worry about credit risk. "Floor guarantee" refers to the general situation where issuers can promote conversion by lowering the conversion price after the underlying stock price continues to fall, thereby reducing the pressure of repaying principal and interest.

However, with the appearance of the first substantial default convertible bond, the "floor guarantee" myth of the convertible bond market for thirty years was completely broken. On May 17, Soo Yoo Te announced that due to insufficient liquidity, it could not repay the redemption principal and interest, and "Soo Te Convertible Bond" occurred a substantial default. In addition, since last year, "Lan Dun Convertible Bond" and "Hong Da Convertible Bond" have successively occurred in the underlying stock and convertible bonds delisting at the same time, "Zheng Bang Convertible Bond" and "Quan Zhu Convertible Bond" have been repaid according to the ordinary debt settlement plan due to the company's bankruptcy reorganization.

The successive appearance of delisting and default convertible bonds has also intensified the market's concerns about the credit default risk of convertible bonds. For example, "San Fang Convertible Bond" was twice concerned by the rating entity and exchange entity in May, once downgraded to "AA-" by the credit rating, and another time was questioned by the regulator, requiring the company to explain whether there is a liquidity risk, etc. Market investors reacted violently to the two exposures of credit risk for this bond, respectively falling by 8.72% and 17%.

A partner of a private equity fund told the reporter, "The sharp decline of 'San Fang Convertible Bond' indicates that investors are paying more and more attention to the exposure of credit risk in convertible bonds. The market's irrational selling is due to the reduction of trust in convertible bonds. The past belief in 'floor guarantee' has been broken. Whether it is AA+, AA grade, or AA- grade convertible bonds, there is a risk of default." According to Wind data statistics by Yicai, last week (June 17-June 23), 11 convertible bond issuers were downgraded, "You Xia Convertible Bond" was downgraded from AA to AA-, and "Wen Tai Convertible Bond" was downgraded from AA+ to AA.

"In the past week, the decline of related convertible bonds on the first day of rating downgrade has significantly increased, and the decline of the underlying stock is relatively small. The convertible bond market pays more attention to the credit risk brought by rating downgrades, and the overall market sentiment tends to be cautious. Under the background of stricter regulation, the rating disclosure period overlaps with the market adjustment period, and the convertible bond market's reaction to credit disturbances is significantly beyond expectations." Liu Xinyang, an analyst at Wanlian Securities, pointed out in the research report.Several industry insiders have pointed out to reporters that the credit risks associated with convertible bonds mainly include the default risk brought about by the issuer's inability to pay principal and interest, as well as the delisting risk of the underlying stock due to touching par value and financial red lines. In the view of Yang Jiefeng from Southwest Securities, the continuous decline in low-priced convertible bonds is mainly due to the fact that the solvency of some issuers of low-priced convertible bonds has been questioned. Although their prices are already low enough, it is difficult to exit through conversion due to the still high conversion premium rate and the underlying stock possibly already facing delisting pressure, making the "attack and defend" strategy potentially fail.

"Many convertible bonds that fell sharply in the early period did not have obvious credit risks, but still broke through the bond bottom," a fixed-income analyst from a public fund told reporters. Under the new delisting rules, the operational flaws of these companies are further magnified, and as the stock price falls close to 1 yuan, the price of convertible bonds also quickly follows suit.

A large number of convertible bond ratings may be downgraded. Convertible bonds, once seen as high-yield, high-win-rate investments, have experienced a significant decline in the early period, especially with low-priced convertible bonds suffering a large-scale sell-off, reflecting the ongoing adjustment in the capital market ecosystem. Several fund practitioners told reporters that market panic has accelerated the clearance of low-quality individual bonds, and this round of adjustment is still ongoing. They will choose to buy convertible bonds that have been wrongly killed and build positions with high-quality varieties. After a period of rebound, when the price of convertible bonds falls back to a safe range, this wave of irrational selling will also come to an end.

The reporter also noticed that as the convertible bond market experienced a "panic" decline in the early period, it was rare for listed company executives to take action to increase their holdings of convertible bonds. On June 24, Lingnan Shares announced that the company's shareholder-related parties intended to increase their holdings of the company's convertible bonds or shares by no less than 28 million yuan. Prior to this, on June 22, Shanying International announced that the company's directors and supervisors intended to increase their holdings of the company's convertible bonds, and at the same time, the board of directors also proposed to revise the conversion price of the relevant convertible bonds.

The scale of many convertible bond ETF funds has also gradually increased. The scale of Bosera Convertible Bond ETF exceeded 10 billion yuan in June, reaching 11.303 billion yuan on the 25th, while the scale was only 9.549 billion yuan on May 31; the scale of HaiFutong SSE Convertible Bond ETF increased from 738 million yuan at the end of May to 979 million yuan on June 25.

There is a view in the market that this move is behind the convertible bond entities actively responding to the irrational decline in the market. Institutional insiders pointed out that after a period of adjustment, the irrational emotions in the market will dissipate, but the current risk of both stocks and convertible bonds falling together still needs to be guarded against.

"The fluctuations in net value or delisting pressure brought about by quasi-credit risk events still need to be focused on and avoided in essence," Liu Yu, the chief economist of Huaxi Securities, pointed out. For varieties that are truly approaching repayment, if the book liquid assets are obviously insufficient, it is not recommended to gamble on the company choosing a premium conversion to solve the problem; the situation closest to credit risk in the convertible bond market is the issuer's delisting, whether it is a substantial delisting or a market concern that triggers delisting, both will cause significant price fluctuations; inquiry letters, non-standard audit opinions, and other historical credit flaws are also very likely to cause net value fluctuations.

Liu Zheming, the chief fixed-income analyst at Northeast Securities, believes that the current credit concern sentiment in the convertible bond market has not yet dissipated, and there are still a large number of convertible bond ratings to be updated in June, with the possibility of a downgrade in convertible bond ratings. Therefore, it is not recommended to participate in the bottom fishing of low-priced bonds in the short term.

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