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A worker pulls a cart in front of the residential and commercial buildings, including the Canton Tower, in Guangzhou, China, in November 2017. A report published by an investment bank noted that work had resumed at half the building sites among developers it covers. Photo: Bloomberg
Opinion
The View
by Nicholas Spiro
The View
by Nicholas Spiro

As the coronavirus tears through financial markets, Chinese real estate bonds are holding the fort

  • While sales are falling and the rise in home prices slowing across Chinese cities, real estate debt remains resilient on the back of decisive government action to contain the spread of the coronavirus and policy support for developers
For an indication of the severity of the disruption caused by the lockdowns imposed by Beijing to halt the spread of the coronavirus, look no further than the collapse in home sales as home builders have been forced to shut their showrooms, while many of their on-site sales offices remain closed.

Last month, contracted sales among 30 mainland developers tracked by Bloomberg fell by an average rate of 33 per cent year on year, the sharpest fall in at least six years despite strenuous efforts by home builders to shift their sales to online channels. In January, house prices in 70 major cities across China rose at their slowest pace in almost two years, and may have contracted last month.

The virus-induced shock to the housing market – which directly accounts for 7 per cent of the country’s gross domestic product, or one fifth of output if indirect contributions are included, data from Bloomberg shows – has squeezed developers’ cash flows.

With the proceeds from presales of apartments constituting the most important source of funding for property firms, an increasing number of distressed developers are going bust, while some of the weaker players risk defaulting on their US dollar-denominated bonds.

In a report published by Standard & Poor’s last week, the rating agency warned that “declining sales will hurt developers’ liquidity”, adding that “several companies already in the ‘CCC’ category, or with low ratings with negative outlooks, may face liquidity issues over the next several months.”

The liquidity squeeze in the sector has been exacerbated by the dramatic declines in global markets over the past few weeks as investors fret about the lack of coordinated and comprehensive measures to address the fallout from the epidemic.
While the selling pressure was initially confined to equities, it has spread to corporate bonds due to mounting concerns about the rapidly deteriorating outlook for companies’ earnings, and the ability of highly-levered firms to continue servicing their debt. The sudden sell-off in credit markets has been amplified by the crash in oil prices.

In the last month, spreads – or the risk premium – on US high-yield bonds have soared by 370 basis points, while spreads on emerging market dollar-denominated high-yield debt have risen by almost 300 basis points to their highest level since 2016, data from JP Morgan show.

However, at the country level, the sell-off has varied greatly in its intensity.

A man works at a construction site of a residential skyscraper in Shanghai in November 2016. The housing market accounts for 7 per cent of China’s gross domestic product. Photo: AFP

Spreads on Chinese dollar bonds – which have the largest weighting in JP Morgan’s benchmark Corporate Emerging Market Bond Index – widened by just 35 basis points in the month leading up to March 6.

Even in the more vulnerable high-yield category, spreads rose by only 77 basis points, compared with increases of between 142 and 175 basis points for Russian and Mexican junk bonds, many of which are issued by firms in the hard hit commodities sector.

Indeed, Chinese property companies – which account for the bulk of the Asian high-yield debt universe – sold US$16.5 billion in offshore bonds in January, an all-time high for the first month of the year, according to S&P, allowing developers to build a capital and refinancing buffer just before markets collapsed in late February.

Infrastructure bonds in demand as China moves to boost virus-hit economy

The relative resilience of Chinese real estate debt stems from a confluence of factors.

First, Chinese assets have weathered the turmoil in markets remarkably well. The Shanghai Composite Index has barely budged over the past month, as the world’s other leading equity gauges have tumbled into bear markets.
Second, markets have crashed partly because of the rapid spread of Covid-19 in Europe and the US. In China, by contrast, draconian measures to contain the epidemic appear to be paying off. The daily growth rate in infections has dropped close to zero, compared with a rapid acceleration in the US and persistently high levels in Europe.
Third, and most importantly, sentiment in Chinese debt markets is determined by the policy response in Beijing, and not in Washington or Frankfurt. With real estate playing such a crucial role in China’s economy, investors believe the epidemic marks the end of the corporate deleveraging campaign and that Beijing will provide the necessary liquidity to support developers.

While policymakers in the US and Europe are belatedly providing more forceful stimulus, markets have more faith in China’s ability and willingness to boost growth.

On Friday, the country’s central bank cut reserve requirements for banks, providing an extra US$79 billion in liquidity. This came on the heels of more targeted measures by local governments to ease the cash crunch faced by developers.

Shenzhen eases housing rules for builders to avert cash crunch amid slump

Fourth, more accommodative financial conditions come at a time when developers’ sales offices are reopening and construction activity is resuming.

A report by JP Morgan published earlier this month noted that, among the developers the bank’s research team covers, 60-70 per cent of sales offices had reopened, while work had resumed at half the building sites.

A woman points at the model of a residential compound by China Vanke at its showroom during the National Day “Golden Week” holiday, in Dongguan, Guangdong province, in October 2018. Many developers are reopening sales offices as the coronavirus threat abates. Photo: Reuters

To be sure, the severity of China’s virus-induced downturn will prove too much for many weaker developers, especially if the housing market does not recover as quickly as many believe. Yet, rising levels of distress in the sector create opportunities for stronger domestic and foreign real estate groups.

In a report published in January, CBRE noted that opportunities will arise for debt investors “to offer development loans or junior and mezzanine debt” and for equity investors given that Chinese developers “will be more willing to offload non-core assets to recycle capital”.

At a time when global markets are facing their biggest crisis since 2008, Chinese real estate debt provides more upside than most other asset classes.

Nicholas Spiro is a partner at Lauressa Advisory

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