China high-yield surges further, as investors seek offshore real estate

Overlooked during the COVID-19 crisis, Chinese US dollar-denominated high-yield property bonds have since experienced significant uptake

At the height of the COVID-19 crisis in March and April 2020, Chinese high-yield issuers found themselves almost shut out of the US dollar bond market, as investors looked to assets deemed more resilient to the new financial crisis.

Prior to these months, regulatory restrictions already in place made it challenging for Chinese high-yield issuers to raise offshore. Liquidity was in limited supply and defaults loomed.

Conversely, the onshore renminbi market remained robust. At a virtual roundtable hosted by GlobalCapital and Standard Chartered in mid-April, industry leaders outlined the attributes contributing to the resiliency of this market. During the discussion, officials from Chinese real estate companies acknowledged the difficulties facing offshore issuance but remained optimistic that the market would rebound. They were proven right.

By end-July, when a follow-up virtual roundtable took place, the offshore high-yield property market had fully recovered, with issuance volumes higher than before the crisis. Secondary market trading has since remained strong, and most new issues are at or above par.

What changed?

Governmental support

Bonds issued by Chinese companies overseas with maturities of more than one year require approval from the National Development and Reform Commission (NDRC). Given the volatility of the global markets during the past decade, many issuers faced limiting quotas.

Since the tightening of the offshore bond market, however, the NDRC has granted many Chinese companies the quotas they require. “We are seeing a lot of deals now,” enthused Eugene Fung, Senior Portfolio Manager, Head of Credit and Equities at BFAM Partners. “The good thing is that a lot of these issuers are issuing new bonds while tendering for old bonds. And that new issuance is not that big, so the market is very easily absorbing it.”

Overseas governments and central banks also played a part in propping up the market and reducing the risk of defaults. “Some issuers that would have been at risk have found ways to source capital because of the global support from central banks and governments,” explained Simon Cooke, Portfolio Manager, Emerging Markets at Insight Investment. “Because of that, we have seen issuers take advantage of the market recovery and we have seen a healthy supply of China high-yield.”

Some property issuers that pre-funded before the crisis have since done so again for 2021. This has boosted the liquidity positions of these companies to levels above those held earlier this year.

Market momentum

Unlike other major economies, China rebounded quickly from the pandemic-related economic crisis. Since March, the country’s economy has seen a V-shaped recovery. Its resumption, combined with government support and lower funding costs, prompted issuers and property buyers to return to business as usual. Offshore high-yield property bonds too regained their popularity.

“It is a function of which credits benefit first in an improving environment from a liquidity standpoint,” said Fredric Teng, Head of High Yield, Capital Markets, Greater China and North Asia at Standard Chartered. “From a credit profile perspective, the higher-rated names have outperformed on the recovery.”

The BBB- January 2030 bond issued by Country Garden Holdings, for example, was trading at between 101 and 102 cents, before dropping to about 90 cents during the crisis. Its pricing swiftly recovered, and it is now trading between 104 and 105 cents1. In comparison, B+ Zhenro Properties Group’s 2024 bond dropped from 99 cents to about 72 cents, before gradually recovering to the current 99 cents2. Pricing has since become much tighter, Teng noted.

Investors that capitalised on these movements have benefitted enormously. “Back in April we saw a once-in-a-decade opportunity as a fundamental value investor to generate very healthy returns, [sometimes] double-digit returns, over the coming 12 months. And we have already seen that happen,” enthused Cooke.

Risks and ratings

Not all issuers have prospered, however.

“We have done quite a few negative rating actions on the lower-rated homebuilders, mainly on refinancing risk and liquidity issues,” outlined Adrian Cheng, Senior Director, Asia Pacific Corporates at Fitch Ratings. “The risk is still there, where they struggle to generate sales and they do not have enough access to the offshore market. They may have access to the onshore market but their ability to pump that cash offshore is limited and it takes time.”

Cheng does not expect further downgrades at present. Should the market worsen, however, there might be more.

Despite improved market conditions of late and the positive performance of high-yield property bonds in general, Cheng believes it is too soon to expect upgrades.

“There are a few things we need to be mindful of in terms of an upgrade,” he explained. “One thing is the homebuilders’ ability to generate sales and sustain the sales at a certain scale while maintaining the relatively conservative credit metrics and policies. And at the same time, they plan to refinance well in advance.”

If these are achieved, Cheng added, upgrades for some companies are possible.

Future developments

China’s environmental agenda, as highlighted in the 13th Five-Year Plan3 (2016–2020), promotes the construction of eco-friendly buildings. Property issuers typically fund these through green bonds, of which China is the world’s top issuer, issuing CNY386.2 billion (US$55.8 billion) last year4.

Green bonds present Chinese real estate issuers with a new pool of investors: including those mandated to purchase the asset class. Increasingly, Chinese companies are establishing green bond frameworks, which outline to investors the proceeds to be funded from such bonds. “With a green bond label, they may be able to give me a bigger order size,” quipped Kenny Chan, Chief Financial Officer of Zhenro Properties Group.

Interest in environmental, social and governance (ESG) matters is expected to grow — not only among local and overseas investors, but within Chinese companies as well. “Last year we established an ESG committee,” enthused Lawrence Leung, Head of Capital Markets and Investor Relations at CIFI Holdings. Leung’s company plans to use its green bond framework as one of its key financing channels in future.

Overall, fewer issuances are expected over the following months, given that traditionally August and September experience less market activity. There could be a dip in Q4 as well - as November’s US presidential election may disrupt markets, and impact investors considering purchasing Chinese assets. This may in turn dampen the ability of some Chinese issuers to raise capital and meet their repayment obligations.

Prudence is therefore required. “Investors do need to look at the issuers specifically. They shouldn’t blindly buy a sector,” cautioned Gerhard Radtke, Partner at Davis Polk & Wardwell. “It is, after all, a high-yield market.”

Read the full article on the roundtable discussion here.

1 https://www.bondsupermart.com/bsm/bond-factsheet/XS2100726160

2 https://www.bondsupermart.com/bsm/bond-factsheet/XS2099413093

3 https://en.ndrc.gov.cn/policyrelease_8233/201612/P020191101482242850325.pdf

4 https://global.chinadaily.com.cn/a/202006/30/WS5efab476a310834817256233.html

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