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Callables offer new play on Asian corporates
Creditflux Ltd. (October 31, 2005)

Indian convertibles and Asian high-yield action narrows spreads

Prompted by a dramatic collapse in credit spreads, credit derivative market makers in Asia have begun offering a new kind of credit default swap on Indian convertible issuers. The sector has been one of the region's most active in the past 12 months, with hedge funds using credit default swaps to hedge the growing number of convertibles issued by Indian companies.

Dealers are offering prices on between 10 and 15 Indian convertibles, with Morgan Stanley, Barclays Capital, Deutsche Bank and Citigroup regarded as the leading market makers. Bid-offer spreads are said to be wider than for many other markets, but are usually no more than 20 basis points.

According to Karan Chadha, a managing director at Washington Square Capital in London, the sector has been a spectacularly successful long play since the spike in spreads following India's parliamentary elections last year.

"These names started out in the 300bp-plus range, " says Chadha. "But as more people become comfortable with these names and realised that they are solid companies, spreads have tightened substantially. Most of them now trade at below 100bp. "

Washington Square, a credit investment manager with a focus on relatively exotic assets, is typically involved as a seller of protection on Indian names. Chadha points out that if an issuer converts its bonds into equity, the protection seller stands to make a big gain since there are typically no other bonds that the protection buyer can deliver into the contract. Indian credits trade with foreign-currency bonds as the only deliverables, and, other than their convertibles, most have only domestic borrowings.

As a result, some dealers have begun making a market in callable credit default swaps on Indian names. These contracts pay a premium over regular credit default swaps but allow the hedger to unwind the trade without a penalty if the underlying asset converts into equity.

Callable trades are mostly quoted on a private basis. "We do trade callable credit default swaps on Indian convertibles, " says Will Pang, head of credit trading at Barclays Capital in Hong Kong. "But those trades are typically between dealers and customers. The street trades these names without a call option. "

The most widely traded Indian credits are banks such as ICICI and HDFC, which are quoted in the 80-90bp range, and some of the country's largest corporates such as Reliance, Tata Motors and Bharti Televentures, all of which now trade at below 100bp. However, some traders report increased trading in the growing number of smaller convertible issuers. One of the few names trading above 100bp is pharmaceutical company Wockhardt, which was quoted by one dealer last month at 125/155bp.

"There are around five or six new convertible issues a month, " says Chadha at Washington Square. "But most of them are small deals of only $50 million or so, and it can be hard to find counterparties to trade these names. However, trading is spreading to some of the less liquid names. "

While the list of Indian convertible issuers continues to grow (a recent report by Barclays Capital puts the market capitalisation of Indian convertible bonds at $5. 3 billion), credit traders are also turning their attention towards other corporates in Asia as a source of spreads. Traders report that for the first time, a small number of active borrowers have begun to trade on their own fundamentals, rather than simply in line with their sovereigns. In many cases, these are Asian companies with listings and borrowing programmes in Europe or North America.

"There are really two different kinds of corporates being traded in Asia, " says Pang at Barclays Capital. "There is the Indian convertible market, where we have seen a huge appreciation in the more liquid names. Then there are the real Asian high yield corporates, names such as Vedanta, Noble Group and Pemba Gas. "

Among the widest of these high yield names are Sino Forest, a pulp and paper company with its headquarters in Canada but most of its operations in China. The credit has been trading around 265-280bp for some time according to Pang at Barclays Capital. Another actively traded credit is Singapore trading company Noble Group, which is in the 220-250bp area according to Pang.

Meanwhile, possibly the most actively traded high yield name in recent weeks has been Vedanta Resources, a UK listed metals and mining company with most of its business in India.

Vedanta has bucked the recent tightening trend, widening out to beyond 200bp on the back of concerns about corporate governance, and the company's expansion plans.

Michael Peterson



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