Government involvement

Over the past few months, investors have been asking the question: will the Chinese government step in to save Evergrande and stabilise the market? Or will they take a hands-off approach and let the chips fall where they may?

The answer seems to be that the government is no longer prepared to risk economic instability. This week the Communist Party’s Politburo stated that the country’s economic decision-making for 2022 will “put the word of stability as the top priority”. At almost the same time, the government signalled their involvement in an Evergrande debt restructuring process, likely one of the biggest ever seen in the country’s history.

A risk committee has been announced, comprising the Evergrande management plus officials from Guangdong and several state-backed institutions. On the face of it, this committee is Evergrande focused, and will be seeking ways for the company to restructure its business and to deal with its US$ 300 billion in debt obligations, plus resolve the socially disruptive issue of millions of uncompleted apartments across hundreds of cities.

Liquidity challenges

But Evergrande is just one of many developers now facing a debt crunch, with at least 10 having already defaulted. According to Bloomberg, China’s developers face around US$ 1.3 billion of bond payments in December alone, with elevated bond maturities in the first half of 2022 compared to the second half of 2021.

These developer woes are exacerbated by the inability to raise fresh funds. Despite recent reports that the government is easing up on credit measures to boost liquidity, uncertainty reigns. As a result, debt issuances have now fallen two months in a row. To address its liquidity pressures, embattled property group Kaisa offered to exchange at least 95 percent of its USD 400 million 6.5 percent note, maturing December 7, for new notes with the same coupon maturing June 2023. But this offer has failed to garner sufficient support and the company now looks likely to join Evergrande in requiring debt restructuring.

Figure 1: China RRR Cuts vs JACI China Spreads

Source: UOBAM/Bloomberg

On the plus side, China’s central bank, the People Bank of China (PBOC) announced this week that it is cutting its reserve requirement ratio (RRR) for the second time this year. Starting December 15, the reduction of 0.5 percentage points for financial institutions releases interbank liquidity worth 1.2 trillion yuan (US$188 billion). The market expects some of this to flow into the property sector, thereby helping to stabilise Chinese high yield spreads. However, in our view, more RRR cuts such as those seen in 2018-2019 may be needed for spread tightening to be significant.

Asia impact

China’s property woes have had spillover effects on other Chinese high yield sectors, especially given rising inflation and the ongoing pandemic challenges. But as with other Chinese downward spirals, this one has dragged Asian high yields into its vortex. As a result, Asian high yield credits have underperformed their global counterparts. Month-to-date, the JP Morgan Non-Investment Grade Asia Credit Index (JACI) returned -0.16 percent and has fallen 10.35 percent since the start of the year.

Despite recent developments, we expect high-yield corporate spreads in Asia to remain at elevated levels until a significant resolution is reached for these developers. While we think that the downturn is near the bottom, the reduced liquidity in the short term suggests that a significant turnaround in credit sentiment is unlikely in the opening weeks of 2022.

Asia High Yield vs High Grade Spread Change: Dec 2020 – Oct 2021

Source: UOBAM/Bloomberg

That said, the Asian high grade space, except for Chinese high grades, appear to be relatively rich and therefore less attractive. Once Omicron fears abate, valuation factors kick in and the search for yield resumes amid rising inflation, Asian high yields look likely to come back into favour. This leaves room for credit selection opportunities.