Worry Easing Over Developers' Offshore Debt
Rebound in real estate bonds, vows to address strains cited by experts
There is growing evidence of a silver lining to concern over the potential for some Chinese developers to default on offshore debts, experts said. The potential has jangled global investors' nerves since real estate giant Evergrande Group missed payments in September.
Observers point to the fact that the price of real estate bonds has rebounded strongly, and at least 20 Chinese developers announced within a week they would issue or have issued bonds in the interbank market. Officials from central and local levels also have all voiced a commitment to addressing the cash strains of real estate developers.
The financial health of China's real estate sector is deemed so important for global financial stability that the United States Federal Reserve and Treasury Department said they have been paying attention to the sector's stress. The sector generates a quarter of China's GDP directly and indirectly and has offshore bonds worth about $250 billion, according to estimates from PGIM Fixed Income, a global asset manager.
Though the peak of offshore defaults may still be on the horizon, experts said any systemic financial risks or major threat to the global economy would be kept at bay, thanks to Beijing's fine-tuning of real estate deleveraging, the revival in credit conditions and stabilizing market expectations.
Some institutional investors have even started tapping into oversold opportunities offered by quality-name developers after sell-offs, attracted by high yields, cheap valuations and, most importantly, the still stable long-term prospects of the sector.
"I don't think there is going be a (major) economic contagion or financial contagion of the broader sort for the global economy," said Jack Mclntyre, a portfolio manager with Brandywine Global Investment Management.
"The property market as a whole is deleveraging. And when you deleverage in a slower growth environment, there are always some challenges," he said. Yet the challenges should remain manageable as the Chinese government is expected to avoid deleveraging moves being overwhelming and imperiling economic and social stability, which remains at the core of policy priorities, according to Mclntyre.
In a bid to lower risk in the highly leveraged real estate sector and contain property price bubbles, China launched a series of measures starting last year, including the "three red lines" to contain the debt level of selected developers and cap the concentration ratios for bank loans to the real estate sector.
As financing conditions tightened while property sales soured, some heavily indebted developers have had difficulties servicing their debts, with Evergrande's missed interest payments on three of its dollar bonds spooking investors since late September.
While Evergrande avoided official defaults by making the payments later, China Industrial Securities Co found that nine Chinese developers had defaulted on offshore dollar bonds this year, with unpaid claims totaling $28.07 billion.
Amid the rising risk of defaults, an index that tracks the price movement of high-yield Chinese real estate dollar bonds slumped by 39 percent from the start of September to Nov 9 at 219.4 points, the lowest level in more than eight years, according to Bloomberg. The index is calculated by IHS Markit division iBoxx.
The index has since staged a rebound, rising by 20 percent to 263.6 points on Nov 19, as positive policy signals have come in successively and indicated a slight loosening of the real estate financing policy and continuation of the nation's commitment to fend off any systemic financial risks, experts said.
The People's Bank of China－the central bank－and the China Banking and Insurance Regulatory Commission have reiterated the policy stance of maintaining the healthy development of the property sector on different occasions since late September and have instructed banks to maintain steady and orderly lending to the real estate sector.
National-level regulators, self-regulating bodies and think tanks have organized as many as four symposiums with developers in the month leading up to mid-November about addressing their business stress, which experts said has rarely happened, leading to the release of more easing signals.
Aayush Sonthalia, a portfolio manager of emerging markets debt with PGIM Fixed Income, said the worst-case default situation may be avoided as credit conditions have eased.
"There is also an expectation of some loosening of the three red lines policy for asset sales, which would be very helpful," Sonthalia said. "We still think China's property bonds are going to be investable as a whole once the liquidity issues have been addressed."
With a widespread debt crisis among Chinese developers to be fended off while the sector's heft in the global economy remains modest, experts said the risk of contagion from China's real estate stress for the global financial system should also be limited.
According to Sonthalia, the $250 billion or so in bonds issued by the Chinese property sector in the external corporate market is not insignificant, but any risk of contagion for the global financial system should be mitigated by accommodative financial conditions in developed markets, which are significantly bigger in size.
Jack Siu, chief investment officer of Greater China with Credit Suisse, said China's real estate sector and its supply chain are estimated to contribute 5 percent of global industrial production, but most of the sector's activities are confined to the domestic supply chain. Therefore, the sector's stress is expected to have only a limited risk of spreading to the global financial system.
Given that systemic risks should be kept at bay while the property sector's valuation has dropped to a historical low, investment management firm Neuberger Berman is positioning to earn returns from market mispricing on good names, said Peter Ru, the company's managing director and chief investment officer for China fixed income.
"As the real estate sector is an important pillar of the economy, the direction of step-by-step easing should be clear," Ru said. "We expect that by the first quarter of next year, the sector's liquidity situation will be improved, as more time is allowed for easing policies to take effect and potentially more supporting policies to inject confidence to the demand side."
Goldman Sachs has also reportedly been adding a "modest amount of risk" through high-yield dollar bonds issued by Chinese developers, citing that the market might have overpriced the true extent of distress.
Yet Neuberger Berman remains careful with weak developer names, Ru said, as many weaker developers may be pushed out of the market amid falling profit margins and accelerated sector consolidation.
"It's not surprising to see some bottom-fishing moves after rounds of sell-offs from July to early October, as now bond yields of some developers are very attractive compared with US high-yield counterparts," said Matt Simpson, a market analyst with GAIN Capital.
"But we believe investors are taking a very selective approach as some names are still highly vulnerable to defaults, and any default event could once again dampen the valuation of the whole asset class," Simpson said.
Some are even more cautious given the unchanged policy objective of real estate deleveraging despite recent fine-tuning, lukewarm property sales that restrict the room for improvement in financing conditions and the likely yet-to-come peak for defaults.
"We think the key is for sales volume to recover, which is the core of the liquidity problem developers are facing right now," said Siu with Credit Suisse. "So far, we haven't seen enough to bring back consumers. They remain skeptical about developers' financial health," he said.
Also, there is uncertainty regarding how far the authorities will fine-tune real estate policy in the near term given the medium-to-long-term objective of preventing a real estate bubble from developing. Such uncertainty has weighed on the sector's valuation, Siu said.
"Overall, deleveraging reform of the real estate sector has not changed. We don't expect 'easing' of the reform," said Iris Pang, chief China economist at Dutch bank ING.
Sonthalia with PGIM Fixed Income said the peak of offshore bond defaults is still on the horizon, though risks for some better-capitalized developers are receding, with Evergrande's heavy maturity schedule through 2022 making a default still expected.
Estimates show that Chinese developers may face greater repayment pressure in the coming quarters. According to Nomura, the global financial services group, quarterly offshore bond repayment of Chinese developers is estimated to almost double from $10.2 billion in the last quarter of this year to $19.8 billion in the first quarter of 2022 and $18.5 billion in the second quarter.
A separate estimate from China Index Academy, a property research institute, showed a total of 356.02 billion yuan ($55.7 billion) in offshore bonds issued by Chinese developers will mature in 2022, with more than half to mature in the first six months of the year.
To meet next year's payment peak, Chinese developers need to make more effort to improve cash flow stability, accelerate home sales, divest themselves of some assets and be more prudent when bidding for land, said Liu Shui, a researcher with China Index Academy.
"Developers should tighten their belt and break any freehanded spending habits formed in the years of breakneck growth," Liu said.
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