CHINESE property developers' dollar-denominated junk bonds are one of the top 10 emerging-market bets for next year after a slump that's pushed valuations to June 2010 levels, says UBS AG, Europe's biggest wealth manager.

Switzerland's largest bank sees a "sweet spot" for debt issued by Agile Property Holdings Ltd, Country Garden Holdings Co, Longfor Properties Co and Franshion Properties China Ltd, according to a report dated Monday to clients. HSBC Global Asset Management and Clariden Leu AG say they also favor such securities, which yield as much as 15 percent, compared with an average of 8.71 percent for bonds in Bank of America Corp's United States High Yield Master II Index.

"We are only advocating the stronger names or names with state ownership like Franshion," Alvin Ying, a London-based analyst at UBS said in an e-mailed response to questions. "Such companies have adequate liquidity, established brand names, low-cost land banks and better access to funding alternatives," strategists including Ying wrote in the report.

Chinese junk bonds lost 10 percent this year through Tuesday, according to the US High Yield Master II Index. Notes rated below BBB- by Standard & Poor's from US issuers advanced 3.9 percent, India's gained 1.7 percent, Russia's 0.2 percent and Brazil's 1.1 percent. The Chinese debt, most of which was sold by property companies, rallied 20 percent in October following a September loss of the same proportion that marked their worst month in three years.

Property curbs

Property companies' borrowing costs in China climbed this year as policy makers raised the down-payment requirements and mortgage rates on some homes and imposed housing purchase restrictions in about 40 cities to help make homes more affordable. The central bank also increased its benchmark interest rates five times since September 2010 and lenders' reserve requirement ratios on nine occasions.

While curbs on prices and credit have hit property sales, UBS said developers are now focusing on sales in smaller cities and projects and preserving cash, limiting near-term default risks.

Five-year credit-default swaps insuring against non-payment on Agile bonds cost 847 basis points on Tuesday, down from 1,153 on September 29 that was the highest level since April 2009, prices from data provider CMA show. Contracts protecting China's sovereign debt fell to 146 from 180 in that time. A basis point equals US$1,000 a year to insure US$10 million of debt.

Zhongshan, Guangdong-based Agile's 8.875 percent note due April 2017 yielded 12.6 percent on November 9, after reaching this year's high of 19.1 percent on October 5, according to Trace, the price reporting system of the Financial Industry Regulatory Authority. Hong Kong-based Franshion's 6.75 percent bond due in April 2021 yielded 9.36 percent on November 2, compared with 12.4 percent on September 30. Foshan, Guangdong-based Country Garden's 11.25 percent debt due in April 2017 yielded 14.7 percent on Monday, down from 17.6 percent on October 7.

The three bonds remain down 10 to 13 percent this year, according to data compiled by Bloomberg News.

"Valuations are still too low versus rest of the world," said Cornel Bruhin, who helps oversee US$4 billion of emerging-market debt at Clariden Leu in Zurich. "There might be some more volatility ahead in the short term. Over the medium term, a diversified portfolio of Chinese corporate bonds will perform well in 2012."

Bruhin said his funds hold Country Garden and Franshion debt, and added notes sold by Hidili Industry International Ltd in the past two months. While the industry may yet face one or two weak quarters, stronger companies can prepare for "the next upswing," he said.

China-based companies with non-investment grade ratings have raised US$9.2 billion in 22 dollar bond issues this year, accounting for 3 percent of global offerings, according to data compiled by Bloomberg News. There were 15 issues totaling US$6.02 billion in the same period of 2010, accounting for 1.8 percent of total sales.

Issuance increased after monetary tightening pushed up the cost of borrowing at home. The average yield on five-year yuan-denominated bonds rated A in the domestic market, the sixth-highest investment grade, climbed 143 basis points, or 1.43 percentage points, this year to 9.44 percent, according to Chinabond, the nation's biggest clearing house.

"I'm not keen to buy Chinese developers' debt with long duration," said Tadashi Tsukaguchi, senior fund manager of the asset management office at Mizuho Securities Co in Tokyo. "They may perform well in the short term. For the longer term, you have to pay attention to credit risks and it's possible to see capital losses."

Yields on China's benchmark 10-year Treasury bonds gained eight basis points on Tuesday to 3.66 percent, the highest level in a week, and are down 10 basis points this month, Chinabond data show. The seven-day repurchase rate, a gauge of interbank funding availability, rose nine basis points yesterday to 3.39 percent, based on a daily fixing published by the National Interbank Funding Center.

The yuan weakened 0.07 percent to 6.3508 per dollar as of 12:01pm in Shanghai, according to the China Foreign Exchange Trade System. The currency fell 0.02 percent to 6.3585 in Hong Kong's offshore market.

Philipp Good, who manages 581 million euros (US$790 million) of global bonds at Fisch Asset Management AG in Zurich, is shunning Chinese developers' bonds in favor of indirect industry plays through his holdings in China Shanshui Cement Group Ltd and Lonking Holdings Ltd, which makes wheel loaders.

'Different from 2008'

"This time is different from 2008, when most of the companies still had good liquidity and house prices were still appreciating," Good said, referring to the height of the global financial crisis. "The banks are in tightening mode, especially in the property sector."

Chinese housing transactions fell 25 percent to 372.3 billion yuan (US$58.6 billion) in October from September, the first drop in three months, the statistics bureau said on November 9. Sales fell by 20 percent in Beijing and Shanghai from a year earlier, according to SouFun Holdings Ltd, China's biggest real-estate website.

"We are selectively constructive on the double-B names and the one or two odd names in the single-B sector as well," said Gordon Rodrigues, a Hong Kong-based investment director at HSBC Global, who helps oversees US$25 billion of Asian fixed-income assets. Rodrigues declined to disclose which bonds he holds.

While there are risks in some segments of China's real estate market, many regions aren't showing signs of bubbles like the so-called Tier-1 cities such as Shanghai and Beijing, BlackRock Inc said in a report published on its website on October 27.

"The oft-repeated stories of empty apartment buildings have been exaggerated and there is little evidence of exceptionally high vacancy rates," Neeraj Seth, head of Asian credit in Singapore at BlackRock, wrote. "Meaningful regulations have been introduced since 2009 to avoid a real estate meltdown."

Billionaire investor George Soros is planning a property fund to invest in real estate projects in Chinese mainland and Hong Kong, 21st Century Business Herald reported on Tuesday, without saying where it got the information. CBRE Global Investors, manager of US$94.8 billion of real estate assets, said this week it may make its first investment in China's housing market in four years on hopes the government will start easing property curbs.

'Soft landing'

The nation's property market is experiencing a "soft landing" because government regulators imposed timely policy measures to control price rises in smaller cities, Fan Gang, a former member of the People's Bank of China Monetary Policy Committee, said on November 11 in Honolulu. Prices in some of China's big cities may still fall but "overall you will not see a big correction" in the market, he said.

Investors should switch to higher-quality property bonds, offering yields of 12 to 15 percent, from high-risk names that have rates in excess of 20 percent, according to Macquarie Group Ltd, Australia's biggest investment bank.

"Many of the bigger developers will survive even if the government's tight policies continue into the first half of next year," said Dilip Parameswaran, a Singapore-based credit analyst at Macquarie. "Some of the smaller companies may not be able to continue managing their cash flow if their sales do not improve by then."