Tech stocks aren’t the only Chinese assets to crash recently.
According to Paul Lukaszewski, head of Asia-Pacific corporate debt at Aberdeen Standard Investments, spreads on corporate bonds rated B, which vary inversely with price, have jumped seven percentage points over the past month.
Three-year bonds bring in about 18% per annum, higher than during most of last year’s Covid-19 panic. IN
Kraneshares CCBS Chinese Corporate High Yield USD Index
the exchange-traded fund (ticker: KCCB) is down 1.5% in the past two weeks, a fall by fixed income standards.
“Outside of Asia, credit markets are priced at ideal prices,” says Lukashevsky. “In China, this is the price of a crash.”
This could mean a great opportunity in a crop-less world. Or it could get worse before it gets better.
Developers are at the heart of the Chinese corporate bond market and its challenges. About 80 of them issued about $ 200 billion in hard currency debt. Maintaining stable prices for housing, which accounts for nearly 30% of the economy, is a constant concern of the Chinese authorities.
They have aggressively tightened lending this year and set three red lines for builders’ debt ratios. “They’re trying to block the funding channel for developers,” says Tracy Chen, portfolio manager for global lending at Brandywine Global.
It sows fear in a market that is not the most transparent in the world. “One developer is punished for buying too much land, and another for too little,” says Lukashevsky. “Investors come up with reasons to sell.”
One company’s problems are very real:
Chinese group Evergrande
(3333. Hong Kong), No. 2 in China and No. 1 in the world in terms of the share of borrowed funds. He loses assets and quickly sells apartments to raise money to complete the red line. Rating agency Fitch still downgraded Evergrande from B + to B on June 22. Some of his Chinese banks reportedly shut it down.
BUT saving Evergrande will support the rest of the market, predicts Omotunde Laval, head of emerging markets corporate debt at Barings.
“Evergrande is probably too big to fail,” she says. “I believe there is value at current prices.”
However, she concentrates on the more established BB-rated firms such as
CIFI Holdings Group
(884. Hong Kong) or
Shimao Group Holdings
(813. Hong Kong), whose short-term bonds yield about 5%, not double digits.
Sami Muaddi, Lead Corporate Bonds Manager Emerging Markets at
T. Rowe Price,
believes that Beijing may default to Evergrande and a dozen others. “In past cycles, I have been the opposite buyer of Chinese credit,” he says. “This time they are determined to get rid of the moral hazard.”
What’s too big to fail is China’s real estate sector as a whole. Xi Jinping and the company want to keep the floor on existing homeowners no less than the starter ceiling, and are constantly adjusting lending accordingly.
The Council of State, the Chinese equivalent of a cabinet, may have signaled the next pigeon tilt on July 8th. He announced that bank reserve ratios, a key credit control mechanism, could be cut “as needed to bolster support for the real economy.”
This warrants close scrutiny, at least for hungry bond investors.
“We weren’t betting on Chinese developers,” says Aberdeen’s Lukaszewski. “But we are long and we are adding because the risk / reward is so good.”