Could Chinese property developers stress the offshore bond market as policymakers keep reducing leverage?

17 Feb, 2021 05:04
source: WSJ

Singularity Financial Hong Kong February 17, 2020 – Why 2021 Promises a Fresh Wave of Defaults From Corporate China (Source: WSJ by Frances Yoon)

A gap has opened up between rates on junk bonds from China and the U.S., fueling interest in higher-yielding Chinese debt.

This year is likely to bring a series of defaults from China after a string of blowups in 2020. But some investors say they are being compensated well for the risk—and Chinese companies are still less likely to run into financial trouble than their American counterparts.

As of Monday, yields on an ICE BofA index of Chinese offshore high-yield corporate bonds stood at 9.18%, a roughly 4.5-percentage-point premium over U.S. yields. That gulf has largely been driven by a rally pushing down U.S. yields and contrasts with an average difference over the last 10 years of 2.15 percentage point.

At the same time, about 2.5% of Chinese offshore high-yield debt by face value is likely to default this year, according to forecasts from JPMorgan Chase & Co. credit analysts led by SooChong Lim. The bank’s equivalent U.S. forecast is 3.5%.

“China high-yield is extremely cheap versus U.S. high-yield,” said Jean- Charles Sambor, head of emerging-markets fixed income for BNP Paribas Asset Management.

Mr. Sambor said he was happy to invest in bonds from borrowers with single-B credit ratings—around the middle of the junk rating scale—that are systemically important, meaning they could get government support if necessary. His holdings include debt from property developer China Evergrande Group.

Likewise, Alan Siow, fixed-income portfolio manager at Ninety One, said Chinese junk bonds were “particularly attractive, precisely because of the perception of increased risk of credit losses from defaults.” In contrast with that market perception, Mr. Siow said he didn’t expect a meaningful rise in companies failing to repay their creditors.

Still, even a similar number of defaults would mean several corporate collapses. According to Fitch Ratings, a record 12 Chinese companies defaulted offshore last year. That affected more than $7 billion of bonds, also a record. Onshore, a spate of surprising defaults late in the year from borrowers like chip maker Tsinghua Unigroup Co. rattled investor sentiment.

This year, financial stress has already buffeted companies in a number of industries. Industrial-park developer China Fortune Land Development’s dollar bonds are trading at deeply distressed levels after it missed some onshore loan payments, while solar-power group GCL New Energy Ltd. has defaulted on a $500 million bond.

Meanwhile, creditors have demanded a restructuring of HNA Group, which could affect the embattled conglomerate’s ability to repay a $200 million bond that is due this year.

Property developers, which are a big part of the Chinese offshore bond market, could be one source of stress. Regulators late last year told banks to cap their real-estate exposure, while a separate system of “three red lines,” widely reported in the Chinese media but never formally confirmed by authorities, essentially requires more indebted developers to cut their debts.

Shuncheng Zhang, an associate director at Fitch, highlighted risks among smaller home builders with limited funding options and whose land banks, or undeveloped locations, are geographically close together.

Authorities in China have had to balance competing objectives, such as keeping debt under control, avoiding market turbulence and supporting growth during the pandemic.

Policy makers will keep trying to reduce leverage in the system, but might also nudge banks to keep supporting troubled borrowers, said Mark Jolley, global strategist at CCB International.

“They want to encourage more defaults, but they don’t want to have a wave of defaults to the point that it is disruptive to the economy,” he said.

Kenneth Ho, head of Asia credit strategy research at Goldman Sachs, said as China’s economy recovers, the official stance is changing.

“We’re going back to policy normalization, which means going back to the pre-Covid trend of keeping leverage stable,” after a period of easier monetary conditions and forbearance last year, he said.

Mr. Ho expects the default rate to remain high, albeit slightly lower than last year.

“We believe there is value in China credit broadly, but we say that with a big caveat,” he said. “We expect defaults to be elevated. We like the sector, as long as you can manage your tail risks.”