Junk-Rated Chinese Real Estate Bonds: Lingering Risks and Strategic Shifts in a Volatile Market

Investors navigating the tumultuous landscape of Chinese real estate face persistent challenges as the year concludes, with dollar-denominated bonds from junk-rated Chinese developers proving to be a precarious investment, according to money managers. Despite the passage of time, concerns surrounding these bonds linger, signaling ongoing volatility in the real estate sector. The ICE Bank of America Index reports a significant 22% loss in China's US dollar-denominated high-yield bonds, predominantly driven by the burdens of property debt. This marks the third consecutive year of substantial losses, with slumps of 33% recorded in both of the preceding years.

Andy Suen, the co-head of Asia ex-Japan fixed income at PineBridge Investments, a global asset manager overseeing $155.2 billion in assets, maintains a cautious stance. "China’s property sector is not out of the woods," Suen stated. "We don’t have high [confidence] in this sector. We’re still very cautious."

The gloomy outlook is substantiated by the financial struggles of prominent developers, such as Country Garden and China Evergrande Group. Country Garden, once perceived as financially robust, encountered a crisis this summer and proceeded to miss a significant coupon payment of $60 million in October. Meanwhile, China Evergrande Group faces an uncertain future, awaiting a critical hearing next month as its insolvency proceedings unfold.

Suen acknowledges that while a substantial wave of defaults has already occurred, distress continues to permeate the property industry. The post-pandemic economic recovery in China has slowed, impacting sales momentum and causing property prices to soften. "For survivors, we expect further defaults," Suen warned, underscoring the challenges that lie ahead.

Goldman Sachs echoes this sentiment, projecting a persistently elevated default rate for high-yield property bonds into the next year. The continued decline in home sales adds pressure to liquidity conditions, intensifying the financial strain on developers.

In response to the challenging environment, Suen has adjusted the allocation of his fund on Chinese debt, reducing it from 30 to 35% to approximately 20%. This strategic shift includes divesting from bonds issued by Dalian Wanda and Country Garden units. Additionally, he has reduced investments in local government financing vehicles and some small lenders, citing concerns about their credit health.

"The China property sector [is a] very distressed space. We are still quite pessimistic, and we don’t think the policy support is enough to revive these names," Suen remarked. Instead, he identifies more favorable opportunities in other Asian markets, such as Asian banks and Macau gaming companies, as well as India’s renewable energy sector.

Suen's cautious stance aligns with broader market sentiments, reflecting doubts about the effectiveness of state-driven measures to stimulate home purchases in mainland Chinese cities. Leonard Kwan, a portfolio manager at T Rowe Price, emphasized ongoing efforts to deleverage the property sector, asserting that the process of repairing the sector will be gradual and not an instantaneous fix.

Steven Oh, global head of credit and fixed income for PineBridge, highlighted the persistently negative sentiment surrounding China. He suggests that for investor confidence to return, there needs to be assurance that the worst is behind, emphasizing the need for clarity on the trajectory of the property sector.

In light of these challenges, Suen advocates for diversification away from the troubled Chinese property market. While uncertainties persist, the investment landscape appears to be evolving, prompting strategic shifts to mitigate risks and capitalize on opportunities in other sectors and markets within the broader Asian region.

By fLEXI tEAM