China property: junk-bond party has begun as December rush delivers windfall, leaves Nomura, Goldman at risk of missing the boat
- Chinese high-yield dollar bonds surge 28.5 per cent over the past month as Beijing’s ‘three-arrow programme’ powers turnaround
- Investors hope China’s reopening and Fed’s policy pivot will allow junk-graded borrowers to access offshore bond market again next year
A combination of property stimulus, state-ordered financing lifelines and zero-Covid pivot is lifting months of gloom surrounding the biggest part of Asia’s credit market. Some investors are not waiting for a rebound in home sales, fund inflows or a full China reopening to jump in.
“People couldn’t even catch up with the price jumps,” said Chung, an executive director and money manager at the Hong Kong hedge fund. “We are talking about a rapid rally within one week or so. On a day when bonds are rising, you need to add a 5 per cent premium to the prices you see on the screen to outbid other buyers.”
Chung has bulked up his portfolio by about US$10 million worth of purchases from zero within a month, saying his requests to buy bonds were often met with replies of “no inventory” from brokers. Investors should catch the market rebound early as Beijing seeks to alleviate a credit crunch in the sector.
The early bond party puts credit analysts at Nomura Holdings, Goldman Sachs and Morgan Stanley at risk of missing the boat with their defensive, neutral or underweight stances on Chinese property bonds in their 2023 strategies. There is room for optimism as some high-yield bonds are “over-penalised”, according to JPMorgan Chase.
Speculative-grade dollar bonds from Chinese issuers have produced a sustained rebound over the past six weeks, according to ICE BofA Asian High Yield China Issuers Index, reducing the losses this year to 34.7 per cent. The premium of Chinese high-yield bonds over US government debt – the gold standard in the credit market – has shrunk to 16 percentage points as of December 15, from 31 points in March this year.
Notes issued by Powerlong Real Estate, Country Garden and CIFI Holdings surged. Country Garden’s 8 per cent bonds due January 2024, for example, are fetching about 75 cents on the dollar, versus 14 cents on November 3, according to Refinitiv data.
Wanda Commercial’s 6.875 per cent 2023 notes, which are on JPMorgan’s buy list, have risen by 44 cents over the same period. Powerlong’s 6.95 per cent July 2023 bonds July were indicated at 34 cents versus 8.5 cents.
The market bounced just before China unleashed its “three-arrow programme” by ordering banks to provide up to 4 trillion yuan (US$574 billion) to cash-strapped developers.
“Bond investors, especially those based in Asia, are returning to Chinese property credits, people are looking again at the segment,” Gordon Tsui, Hong Kong-based head of fixed income at Ping An of China Asset Management, said in an interview. “We have also been adding them to our inventory at a measured pace.”
It’s a stark contrast to the market gloom over the past two years. China’s US$2.6 trillion real-estate market has suffered a 10-month slump through November, a stretch that decimated cumulative new home sales by 4.3 trillion yuan from the same period a year earlier. It even infected Chinese high-grade corporate bonds, which have lost 9.1 per cent this year through December 15, according to a separate ICE BofA index.
“A lot of downside risks are priced-in,” JPMorgan’s strategists including Soo Chong Lim wrote in an outlook report on December 2. “We see good risk-reward in selected recovery plays and distressed names”, backstopped by China’s supportive measures for the property sector, they added.
The government has recently announced numerous policy revisions that should significantly support the sector in terms of near-term funding needs,” said Jim Veneau, head of Asia fixed income at AXA Investment Managers.
“The market has reacted very positively to this, essentially repricing the risk to account for this new support,” he said by email. “The important point is there is still significant uncertainty in this sector.”
That is one reason some credit analysts at Nomura and Goldman are telling their clients to stay vigilant. Even some developers backed by the state or local authorities, like Greenland Holdings and CIFI Holdings, have missed payments or defaulted on overseas debt. Others have voluntarily reneged on foreign debt to repay onshore creditors first.
From China Evergrande to Guangzhou R&F Properties to Kaisa Group, developers have defaulted on some US$100 billion worth of bonds over the past two years, JPMorgan estimated. Rating pressure and funding squeeze suggest offshore creditors could be on the hook for capital losses on about US$21.5 billion of junk-bond maturities and US$7.7 billion potential early-redemptions next year, JPMorgan estimates.
“The turnaround in China’s property market is likely to be slow, notwithstanding Beijing’s recent policy pivot,” Nomura desk analysts led by Nicholas Yap said in a report on November 28. “It makes sense to start next year on a defensive footing.” Policy easing has been disappointing, “being slow and insufficient,” they added.
While Goldman is advising its clients to abandon their cautious stance and start buying on the China reopening theme, it prefers Macau casino operators and commodity producers to developers. As the share of property bonds in Asian credit markets has shrunk, the sector no longer has a big sway on performance, it added.
“Risks on the China property high-yield sector have been heavily tilted to the downside over the past 18 months, but we now see the risks as two-sided, and have shifted to a neutral stance,” strategists Kenneth Ho and Chakki Ting wrote on December 4. “The main downside risk continues to be unexpected defaults.”
Between January 2021 and October 2022, 66 Chinese developers defaulted or sought more time to repay creditors, involving 1.1 trillion yuan of liabilities, according to data published by China Chengxin Credit Rating Group. About two-thirds of that was foreign-currency debts, it added.
Private-sector home builders contributed to most of the mess by missing 67 per cent of their repayment obligations, versus an average of 43 per cent across the industry, which includes state-owned developers and mixed-ownership peers.
Some 39 defaulted developers are still in the midst of debt workouts with creditors, involving almost US$117 billion of securities, JPMorgan estimated, including US$56.4 billion in 2022 alone. They included serial borrowers like R&F Properties, Zhenro Properties, Sunac China, E-House and Shimao Property.
Cheapened valuations have not translated into positive returns for investors because defaults in China’s property sector continue to grow, Morgan Stanley said in a November 23 report, sticking to its underweight call. The market needs more time to deal with these defaults before it can start to recover properly, it said.
Hong Kong-based boutique investment bank SC Lowy Financial, which specialises in distressed credit, said that it has exited most of its exposure to the high-yield bonds issued by Chinese developers, including China Evergrande, which it started to invest in late in 2021.
“We are certainly a lot less keen to look at investment in China today,” said Michel Lowy, founder and CEO. “It’s just not really investable for foreign investors. The quality of information disclosure is just too poor.”
Some analysts believe the momentum in China’s economic reopening efforts and more green shoots in the nation’s housing market will help restore confidence in Chinese high-yield bonds. So far, China’s “three arrows” have helped shore up confidence and bolster returns for money managers.
Fidelity International’s US$870 million China High Yield Bond Fund, co-managed by Terence Pang, has returned 42 per cent since November 3 to trim its year-to-date loss to 27 per cent, according to Bloomberg data. Value Partners’ US$539 million Greater China High Yield Fund climbed 24 per cent, narrowing this year’s slide to 31 per cent.
Investors will be monitoring a key risk-appetite barometer: can Chinese property developers raise fresh funds again in the offshore bond market? The funding avenue has been largely frozen since Seazen Group sold US$100 million of one-year notes in June. With the Federal Reserve downshifting to a slower pace of rate increases after recent jumbo hikes, borrowing costs could soon stabilise.
Angus To, deputy head of research at ICBC International, said the offshore market remains shut, making it challenging for high-yield issuers to refinance, even as sentiment has recovered somewhat. A turning point is likely to emerge in the second half of 2023 as policy support takes effect and Fed policy pivots.
“I would be more than happy to see if Chinese developers can raise more funds in the capital markets,” said Tsui of Ping An Asset Management.
If JPMorgan is right, fund managers saddled with steep losses on Chinese junk and high-grade bonds over the past two years would be happy to welcome the US bank’s version of a “high-hopping rabbit” when the new Chinese lunar calendar begins next month.
Lower rate volatility, attractive valuations and a more favourable demand-and-supply scenario should be supportive for the market, it said. Sentiment will recover from extreme pessimism once there is visibility on the reopening of China’s economy and the stability of its housing market, it said.
“We expect sector fundamentals to recover in 2H23, given implementation of policy support and lower inventory level,” the bank added. “Increased funding via the three arrows framework would take time to filter through. If anything, the raft of policy announcements should put a stop to the negative feedback loop.”
Additional reporting by Pearl Liu and Li Jiaxing