Chinese property bonds were a standout success for issuers and investors during 2020, a year characterised by high market volatility. How will they fare during 2021?
While China was the first market to be impacted by the outbreak of COVID-19, it was also the first to recover.
Following two months of shutdown in March and April1, Chinese companies re-entered the bond market, selling hugely successful US dollar deals. Surprisingly, yields withstood the selloff, unlike those of other high-yield markets2. By end-July, the market had fully recovered, with issuance volumes higher than before the crisis.
Real estate borrowers were particularly resilient, with many raising benchmark deals at new low yields. As the year progressed, developers posted record sales, and investor confidence in the asset class grew further. During October 2020, property sales were 25 percent higher than the same month a year earlier3. Cumulative sales for 2020 is expected to grow by an estimated 8 percent4 year-on-year.
Other parts of the high-yield sector were less successful, however. Defaults occurred, and regulators introduced new policies limiting the amount of debt undertaken by issuers.
At a recent hybrid roundtable hosted by GlobalCapital and Standard Chartered, executives representing issuers, investors, banks and ratings agencies discussed recent market developments and the outlook for 2021.
What events are currently shaping China high-yield, and what can participants expect over the next 12 months?
“Three red lines”
With real estate accounting for 29 percent of the nation’s economic output5, the Chinese government is wary of the potential fallout from developers overborrowing. In August, the People’s Bank of China and the Ministry of Housing introduced new financing rules for real estate companies, dubbed the “three red lines”6 by local media. Developers wanting to refinance will reportedly be assessed against three metrics:
- A 70 percent ceiling on liabilities to assets, excluding advance proceeds from projects sold on contract
- A 100-percent cap on net debt to equity
- A cash to short-term borrowing ratio of at least one
At the time of writing, details about how the rules will work in practice and when they will be implemented have not yet been published. Some reports expect these will be rolled out in 2021, while others predict they will be rolled out in stages over the next three years7.
Whether these quotas impact joint ventures (JVs) is also unknown. “A lot of these projects may not be consolidated into the issuers’ balance sheets,” noted Adrian Cheng, Senior Director, Asia Pacific Corporates at Fitch Ratings. “To what extent could a developer transfer a JV project out of the balance sheet to avoid the three red lines? We’re not very clear.”
Lawrence Leung, Head of Capital Markets and Investor Relations at Cifi Holdings, is optimistic the new rules will be effective: “To us it is not a brand-new thing, because most of our funding channels are subject to some kind of quota system. It has always been the intention of the government that the leverage of developers be kept under control.”
While real estate companies mostly weathered the storm, others in the industrials sector struggled. Even before the onset of the COVID-19, industrials companies – mostly state-owned-enterprises (SOEs) – were challenged by underlying structural issues that were exacerbated during 2020. A slew of defaults took place in the industrials space in November8. Defaults by government-supported SEOs in China were previously rare9.
“Not all local governments have the ability or willingness to support every SOE,” explained Simon Cooke, Portfolio Manager, Emerging Markets at Insight Investment. “The most common red flags in industrial names are those with weak business models and thin operating margins.”
Recently announced sanctions banning US investments in 3110, 11 Chinese conglomerates are also a risk to Mainland issuers and US-based investors12. “If one really looks at the details, there are a couple of high-yield issuers that have shareholders on the list. And if one looks at the executive order, it is unclear how it applies to a group of entities,” cautioned Gerhard Radtke, Partner at Davis Polk & Wardwell. How the incoming Biden administration will engage with China is largely unknown, though greater dialogue and diplomacy is expected from the new US President.
Lower yields and waning interest from Asian buyers are prompting China high-yield issuers to find new investors13. Developers like Cifi have been holding virtual investor roadshows, and meeting with specialists on environmental, social and governance (ESG)-related matters to widen their investor base.
With global funds demanding that issuers adhere to high ESG standards, those that meet these can benefit from new sources of capital. “We had an over 35 percent allocation to Europe for our first green bond,” enthused Kenny Chan, Chief Financial Officer at Zhenro Properties. “We don’t treat this as just a marketing strategy. We really want to show that we have exemplary ESG procedures, and we really want to enlarge our investor base.”
Adoption of high ESG standards enables companies to access refinancing that would otherwise be unavailable. “For some sectors, it’s a matter of life or death,” quipped Eugene Fung, Senior Portfolio Manager, Head of Credit and Equities at BFAM Partners, citing the need for coal companies to move into more environmentally sound industries to attract capital.
New financing rules, defaults, uncertainty over China’s future trading relationship with the US, and more will continue to pose risks to issuers. However, positive funding conditions offshore should drive China high-yield further forward in 2021, including greater participation of non-real estate companies, and more JV projects from private developers.
For investors, the global hunt for yield will continue to drive overseas demand for Chinese bonds, as yields elsewhere are expected to remain suppressed14. The transparency typically exerted by Chinese property companies during 2020 is also appealing. Open communication played an important part in attracting foreign investors to China high-yield during the height of the COVID-19 crisis, and will continue to do so through the coming year.
“At the onset of [the COVID-19 crisis] in April, I felt the sector had the ability to be resilient. The question was whether the market was going to be able to accept that messaging,” remarked Fredric Teng, Head of High Yield, Capital Markets, Greater China and North Asia at Standard Chartered. “The issuers were able to respond to the needs of the market and to show transparency with their communication. It's good to see that we have been able to essentially validate our April message.”
Read the full roundtable discussion here.
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