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Cai Yuekun, reporter of Economic Observer At 3 pm on August 1, the convertible bond market had just closed. Zhou Yuan stared at the convertible bond data line by line on the computer screen, carefully counting the low-priced convertible bonds with a yield to maturity of more than 5%. Those convertible bonds that were influenced by market sentiment or oversold due to short-term fluctuations came into his sight.

Since May, the convertible bond market, which has the low-risk feature of "zero default" in the investment market, has suddenly "changed its face". Soute convertible bonds and Hongda convertible bonds have defaulted one after another, breaking the "zero default" history of the convertible bond market for more than 30 years since the early 1990s. With the volatility of the A-share market, the convertible bond market has encountered credit risk shocks. In mid-July, high-ratedGuanghui Convertible BondsSuddenly due to the stockGuanghui Automobile(600297.SH) was locked in delisting as it reached the par value delisting scenario, dealing another blow to the already fragile market confidence.

Since the beginning of this year, the ratings of 45 convertible bond issuers have been downgraded. In addition, the Wind Convertible Bond Low Price Index data shows that among the more than 500 convertible bonds in the market, 174 are included in the index. Among them, more than 100 convertible bonds have fallen below 100 yuan.

Cao Yuanyuan, head of the research and development department of Orient Jincheng International Credit Rating Co., Ltd., said that the main reason for the recent sharp adjustment in the prices of low-priced convertible bonds is that with the tightening of delisting supervision and the accumulation of credit risks of issuers, the market has repriced and adjusted the credit risks of convertible bonds driven by strong risk aversion, especially the recent credit rating downgrade of high-rated convertible bonds (Wingtech Convertible Bond、Shanying Convertible Bondetc.) and events such as triggering trading delisting (Guanghui convertible bonds), further caused the market to pay more attention to and re-evaluate the credit risk of convertible bonds.

As a senior investment manager of a private equity firm in East China, Zhou Yuan believes that the more volatile the market environment, the more risks and opportunities will coexist. He focuses on these "wrongly killed" convertible bonds and conducts in-depth analysis and research.

Institutional investors like Zhou Yuan have begun to reassess the credit risk of convertible bonds. They focus on the fundamentals of enterprises and the overall market trends, looking for targets that are truly worth investing in.

The history of "zero default" was broken

Convertible bonds are bonds that bondholders can convert into the company's common stock at the price agreed upon at the time of issuance. Holders can either buy and sell them in the market, or hold them until maturity to receive principal and interest, or convert them into stocks under certain conditions; the issuer can also force the redemption of bonds under certain conditions.

Convertible bonds have the characteristics of both equity and debt, and are considered by investors to be low-risk assets that can be used for both offense and defense. However, at present, the probability of convertible bond defaults has increased, and the risk of delisting has increased, and investors' belief that "convertible bonds are unlikely to default" has begun to waver.

As August 13 approaches, the Blue Shield Debt Repayment (404001.NQ) of Blue Shield Information Security Technology Co., Ltd. (hereinafter referred to as "*ST Blue Shield") is about to expire. However, *ST Blue Shield disclosed on July 29 that the company's current available cash balance is not enough to cover the total face value of the bonds that are about to expire. This liquidity gap may cause the company to face the risk of default at the critical moment of repaying principal and interest.

In the convertible bond market, three convertible bonds have been forced to delist so far, including the "Blue Shield Delisting". The Blue Shield Delisting was due to the poor performance of the issuer *ST Blue Shield for several consecutive years and the issuance of an audit report with no opinion, and the listing of *ST Blue Shield's stocks and convertible bonds was terminated.

The other two convertible bonds that were forced to delist were "Soute Debt Retirement" and "Hongda Debt Retirement". In May, Souyute (002503.SZ) was unable to repay the principal and interest due to insufficient liquidity, and the "Soute Debt Retirement" issued by the company became the first convertible bond to default substantially. This was like a thunderclap, breaking the myth of "zero default" in the convertible bond market that had lasted for more than 30 years.

In June, the "Hongda Bond Refund" repurchase defaulted, becoming the second convertible bond in my country's bond market to suffer a substantial default since the "Soute Bond Refund".

On July 17, Guanghui Auto disclosed that the company's stocks and convertible bonds will be suspended from July 18, 2024, because the closing price of the company's stocks has been below 1 yuan for 20 consecutive trading days, reaching the trading delisting index. At the same time, the delisting of Guanghui convertible bonds and other derivatives issued by Guanghui Auto will also be implemented in accordance with the relevant regulations on the delisting of stocks.

Affected by the decline in the underlying stock price and the release of default risk, the price of Soute Convertible Bonds fell by 74.43% in May (before the suspension on May 23), and finally settled at 18 yuan before the suspension. In late May, the CSI Convertible Bond Index began to fluctuate downward. As the risks in the convertible bond market were increasingly released, the index accelerated its decline in June and then rebounded. However, in July, the CSI Convertible Bond Index once again started a round of rapid decline.

Why do seemingly stable convertible bonds fail one by one?

Under the comprehensive registration system, especially with the introduction of the new "Nine National Regulations" and the strong regulatory orientation, the A-share delisting rules have been detailed, and the delisting phenomenon has increased significantly. The risk of delisting of underlying stocks has increased, making the corresponding convertible bonds bear the "joint liability" for delisting and default. This has intensified the market's panic about convertible bonds and made investors re-examine the risks of convertible bonds.

China Chengxin International said that since May 2024, the "zero default" history of the convertible bond market has been broken. After the release of the new "Nine National Regulations", many convertible bonds faced delisting risks and credit ratings were downgraded, and there were substantial adjustments. The convertible bond index fell by more than 20% from the beginning of the year, and more than 100 convertible bonds fell below par.

Judging from the convertible bond exit data,Huaan SecuritiesResearch report data shows that the number and scale of convertible bond exits jumped sharply in 2019, and then showed slight fluctuations. In the first half of 2024, 32 convertible bonds were delisted, a year-on-year increase of 28%; the scale of delisting was 49.8 billion yuan, a year-on-year increase of 11%. Corresponding to the "issuance boom" of convertible bonds in 2019, a large number of large convertible bonds are about to expire or face redemption.

China Chengxin International believes that the convertible bond market as a whole is still dominated by medium and high-quality entities, and the downward valuation is affected by the combined impact of short-term credit risk events and rating downgrades. The overall market risk is still controllable and the probability of large-scale defaults is relatively low.

Intensive downgrades

The forced delisting storm in the convertible bond market, like a domino effect, quickly triggered a chain reaction in the market.

On July 27, Lingnan Ecological Culture and Tourism Co., Ltd. (002717.SZ, hereinafter referred to as "Lingnan Shares” disclosed that United Credit Rating Co., Ltd. (hereinafter referred to as “United Credit”) recently issued an “Announcement on Downgrading the Credit Rating of Lingnan Ecological Cultural Tourism Co., Ltd. and Related Bonds”, and rated the company’s long-term credit rating as B-.Lingnan Convertible Bond” has a credit rating of B-.

Lingnan shares said that as of the end of the first quarter of 2024, the company's monetary funds balance was 247 million yuan, and the overall collection of accounts receivable did not meet expectations. As of July 19, 2024, the remaining amount of "Lingnan Convertible Bonds" was 645 million yuan, and the company's existing monetary funds were insufficient to cover the redemption amount of "Lingnan Convertible Bonds". The company is short of funds, and there is a redemption risk for "Lingnan Convertible Bonds".

“Tong 22 Convertible Bond" is the only convertible bond in the current convertible bond market whose credit rating has been upgraded.Tongwei SharesBased on a comprehensive analysis and evaluation of the company's operating conditions and other relevant circumstances, the Credit Rating Report on Tongwei Co., Ltd.'s Tong 22 Convertible Bond was issued on June 12. The company's main credit rating result was "AAA"; the rating result of "Tong 22 Convertible Bond" was "AAA", and the rating outlook was "stable".

According to statistics from China Securities Credit Rating Co., Ltd. (hereinafter referred to as "China Securities Credit Rating"), from January to July 2024, the entity level of 45 convertible bond entities was downgraded, an increase of 73% over the previous year.

Minsheng Securities Research Report pointed out that from the perspective of the ratings before the downgrade, the absolute number of convertible bonds with AA- and A+ ratings that have experienced rating downgrades is the largest; but from the perspective of relative proportion, the probability of convertible bonds with A+ and A ratings experiencing rating downgrades has increased significantly. From the perspective of industry distribution, the number of convertible bonds with rating downgrades in the power equipment and pharmaceutical and biological industries is the largest, while the relative proportion is higher in the agriculture, forestry, animal husbandry and fishery industries, which is related to the continuous de-capacity of the pig breeding industry and the substantial losses of most listed companies in 2023.

Shi Xiaoshan, a senior researcher at the Research and Development Department of China Securities Credit Ratings, said that the reasons for the downgrade of convertible bonds mainly include the following: first, the profitability of the main business has declined; second, the operating cash flow has deteriorated; third, corporate governance defects; fourth, the risk of asset impairment; fifth, the rapid growth of debt and its short-term nature, which has put pressure on concentrated repayment; sixth, the unique risks of convertible bonds; and seventh, other aspects include weak external credit enhancement effects, uncertainty in the realization of credit enhancement assets, the issuance of non-standard audit reports, large amounts of litigation, and large amounts of overdue debts.

Cao Yuanyuan believes that through review, we can see that the main reason for the intensive downgrade of convertible bond ratings in this round is that, dragged down by factors such as the macroeconomic downturn or industry prosperity, the profitability of the assessed entities has declined sharply, operating performance has continued to lose money, operating cash flow and debt repayment indicators have deteriorated significantly, and they are facing great concentrated repayment pressure in the short term. In addition, the rising risk of large-scale goodwill impairment, the excessively high proportion of pledges by major shareholders, the continuous overdue corporate debts, and the great uncertainty of actual control are also important reasons for the downgrade of the ratings of some assessed entities.

Cao Yuanyuan said that although the factors that led to the downgrade of the credit ratings of convertible bond issuers in this round are relatively complex, the core elements that determine the credit ratings of convertible bonds are the issuer's sustained profitability and debt repayment ability. Other types of event shocks or adverse situations that trigger rating concerns are also considered in view of their possible negative impact on the company's profitability or short-term debt repayment pressure.

Investment cooling

"Considering the decline in convertible bonds and market turnover in the past two months, the company will not add more convertible bond positions at this time," said Zhou Yuan.

The second quarter report of public funds showed that the number of public funds investing in convertible bonds in the entire market was 2,031, a four-year low; the cumulative market value of convertible bonds held by public funds was 276.165 billion yuan, with a clear trend of continued decline.

also,Sealand SecuritiesThe research report data pointed out that the "fixed income +" products are divided into three groups of low, medium and high elasticity according to the average of the equity positions (stocks + 50% * convertible bonds) in the past four quarters, with 10% and 25% as the critical values. In the second quarter of 2024, the investment of the high elasticity group of fixed income + funds in most types of assets increased, only the investment in government bonds decreased, and the investment in interbank certificates of deposit increased significantly, up about 378% quarter-on-quarter. The investment of the medium elasticity group of fixed income + funds in convertible bonds decreased by 22% quarter-on-quarter, and the investment in interbank certificates of deposit and short-term financing bonds increased significantly, up 63% and 35% quarter-on-quarter respectively.

From the perspective of the outstanding scale of convertible bonds, Zhongzheng Peng Metadata pointed out that the delisting and default events of convertible bonds since 2023 have brought certain fluctuations to the valuation of convertible bonds, and the tightening of convertible bond issuance policies have comprehensively affected the supply and demand of the convertible bond market. Since 2023, the outstanding scale of convertible bonds has declined month by month. As of the end of July 2024, the outstanding scale was 792.7 billion yuan, a decrease of 9% from the end of 2023.

Shi Xiaoshan believes that similar to the impact of any risk event in the past, when it is impossible to reasonably assess current risks in the short term, investors will choose to look for new investment targets.

She said that on the one hand, since 2024, the volatility of convertible bond valuations has increased, causing fluctuations in fund returns, and public funds have strategically withdrawn from some varieties; on the other hand, the credit risk impact of convertible bonds has affected the sentiment of institutions to increase their allocations. Judging from the changes in fund positions in the second quarter, public funds increased their holdings in power equipment, automobiles, electronics and other industries, and reduced their allocations to securities convertible bonds and varieties with weak credit qualifications. By adjusting positions, the impact of negative events can be reduced. Overall, debt-biased varieties are still the focus of fund holdings, but the marginal increase has slowed down, and the direction of internal investment has been adjusted.

Cao Yuanyuan said that as the delisting channel for listed companies is opened, the delisting risk of weak-qualified and high-risk convertible bonds has increased significantly, and credit risk has become an important factor that public funds must consider when evaluating the investment value of convertible bonds. However, since the market's assessment and pricing of convertible bond credit risk is still in the early stages of exploration, and the prediction of convertible bond delisting and default risks is relatively complex, low-priced convertible bonds are more likely to fluctuate significantly due to market sentiment, which also increases the difficulty for public funds to make investment decisions based on the actual credit risk of individual bonds and market cognitive biases.

Credit risk reshaping

As the probability of default increases and the risk of delisting grows, investors are beginning to reassess the credit risk of convertible bonds.

Before 2022, the convertible bond market was once a popular choice for investors. “Investing in new shares with a blind eye” was once a popular strategy for individual and institutional investors.

Zhou Yuan recalled that in 2021, individual investors were once eager to invest in convertible bonds. They did not need to have an in-depth understanding of the fundamentals, and could earn returns with simple indicators and strategies, which undoubtedly promoted the popularity of the convertible bond market that year. However, by the beginning of 2022, the convertible bond market had become "expensive", and investors entering the market at this time were tantamount to taking over at a high level. In the past, institutional investors could "close their eyes and buy new shares" in the convertible bond market through various methods such as sub-account arbitrage. However, with the strengthening of supervision, these arbitrage methods that exploit system loopholes have gradually been blocked.

In Zhou Yuan's view, the convertible bond market has undergone significant changes since 2024. The disappearance of the arbitrage mechanism has made the market pay more attention to fundamental analysis. He firmly believes that the real investment value comes from an in-depth analysis of the fundamentals of the company. Adhering to value investment will eventually gain a relative advantage in the market.

Currently, Zhou Yuan has added a new daily task: intensive communication with clients to ensure that they understand and accept the high volatility of convertible bond investment. He has taken the following measures to persuade clients: first, emphasize the importance of not redeeming in the short term to avoid tax fees and maintenance costs caused by redemption; second, remind clients that the credit bond market investment has experienced more severe situations in the past, such as real estate defaults, which are much more terrible than the current market environment.

Looking ahead, Cao Yuanyuan believes that the convertible bond market will continue to maintain a volatile consolidation pattern in the short term. This is mainly because the current credit risk is an important factor affecting the convertible bond market sentiment and investment decisions. The macroeconomic data for the first half of the year and the micro data of some listed companies disclosed in July are still difficult to provide strong positive support for the convertible bond market. However, among the low-priced bonds that have fallen below par, 70% of the underlying stock prices are above 5 yuan, with an average remaining term of nearly four years. There is still a distance from trading delisting and maturity repayment and resale default, and most of them have no obvious credit risk, while the average yield to maturity has risen to 7.99%. In the short term, in the current low-interest rate environment, the market's risk aversion has led to the wrong killing of weak-quality convertible bonds with no obvious credit risk, which also provides a phased opportunity to increase debt income.

Shi Xiaoshan believes that convertible bonds, as a combination of stocks and bonds, have both stable bond returns and additional conversion income space. This is attractive to investors. At present, the convertible bond market is in the stage of industry rectification, and risk management is becoming stricter, which will be conducive to timely disclosure and transfer of risks and improve market pricing efficiency. In the short term, the restoration of market sentiment still depends on the recovery of the underlying stock market. Convertible bonds may show large net repayments this year, and related risks may continue to be released, which will help promote repricing, reconstruct investment strategies, and calm market sentiment. Investment in the convertible bond market will maintain a differentiated trend in the second half of the year.

Although the convertible bond market is still sluggish, Zhou Yuan remains cautiously optimistic. In his view, as market sentiment stabilizes and fundamentals improve, some convertible bonds that have been mispriced by the market still have a chance to rebound. He will continue to pay attention to market dynamics, look for suitable trading opportunities, and do a good job of risk management. He feels that the prices of these convertible bonds will eventually reflect their intrinsic value. Even in the most undesirable circumstances, they can realize their value through maturity and redemption.

(At the request of the interviewee, Zhou Yuan is a pseudonym in the article)