The long drawn out property sector crisis continues to roil China’s $735bn offshore bond market, despite an 80% sentiment-driven rally in Chinese high yield dollar bonds from November through January.

The rally has since fizzled out, even as distressed developers outline some progress with their debt restructurings. China Evergrande, the world’s most indebted property developer, finally unveiled plans to restructure $19bn of its offshore debt in early April after repeatedly missing its own self-imposed deadlines earlier.

China Evergrande sees the development as a ‘substantial milestone’, but PineBridge’s Omar Slim believes it’s only a marginally positive move. Having resolutions with some of the distressed developers could remove the overhang, but it was not a game changer, said Slim, PineBridge’s co-head of Asia ex-Japan Fixed Income and portfolio manager.

‘To have another leg higher, you need to have some fundamental data improving. You need to have sales in China pick up and you have to see some stabilisation in terms of prices. You have to essentially see some activity, which [nevertheless] is coming back,’ said Slim.

In March, China’s home sales rose for a second straight month, climbing 29.2% from a year earlier to RMB 660.9bn ($96bn). That followed February’s sales, which saw the first increase in 20 months, pointing to signs of the housing slowdown abating. The uptick was also reflected in new home prices rising after months of negative growth.

Activity is likely to improve in the second half of this year, but Slim cautioned: ‘This does not mean some of the distressed names are going to come back from the land of the dead. The reality is, frankly, a large part of that segment is gone. A lot of developers are gone and that market will continue but will be much smaller than it used to be.’

According to Morningstar data at the end of December, PineBridge’s Asian High Yield Total Return strategy held Chinese developers including Road King Infrastructure, Country Garden, Yanlord Land (HK), and Seazen Group.

Paradoxically, as the housing sales data accumulates, it becomes more difficult for certain developers to survive, said Slim. ‘If you continue to see that divergence between developers − if you are a home buyer in China, you’re not likely to buy an apartment from [stressed names] − that becomes a self-fulfilling prophecy accelerating their demise. That’s a big risk for some of them,’ he said.

China’s surviving developers

The survivors in China’s property market will also become more apparent.

‘There may be a bifurcation of currently performing [Chinese property] bonds and those bonds that have defaulted and are going through restructuring,’ said Wai Mei Leong, Eastspring Investment’s fixed income portfolio manager.

‘The performing names may rerate higher if the physical market recovers meaningfully in the latter part of the year, while the defaulted/restructured names may still face challenges in accessing funding in order to complete their ongoing or stalled projects,’ said Leong.

The market was at a crossroads, reviewing and rethinking which companies were positioned to endure in the longer term, such as those positioned with tier-1 property projects or those with more commercial properties with rental returns, Leong said.

The consolidation was likely to continue until a sustained recovery in primary home sales was observed, said Judy Kwok, Manulife Investment Management’s head of Greater China fixed income research.

‘Initial excitement at the comprehensive supportive package to the sector by the government has largely been digested,’ Kwok said. ’After we see the government’s support toward the funding environment for the property sector, the market needs to see fundamental improvements.’

China’s property high yield (or junk) bond rally earlier had been galvanised by Beijing’s bevy of support measures for the crisis-hit sector. Authorities softened the ‘three red lines’ rules in January to ease the liquidity crunch for certain property firms following last November’s sweeping relief package.

The recently concluded annual meeting of China’s parliament in March also underscored Beijing’s intention to prevent the sector’s disorderly behaviour while rolling out incremental measures to support developers’ funding access and improve home-buying activity.

‘These policy announcements strengthened our conviction that there will be some survivors among Chinese developers,’ said PineBridge’s Slim.

‘Towards the end of the third quarter last year, the selloff was completely indiscriminate, where all the names were becoming distressed regardless of what the fundamentals were,’ he said. Beijing’s support measures had allowed the market to be more discerning, affirming Slim’s view that the stronger names would be able to survive.

The property sector recovery should first come from the secondary market, followed by improved primary sales by stronger players such as state-owned enterprises, said Kwok. Private-owned enterprises would lag behind in sales recovery.

Other early signs of the market healing were the higher visitation and better secondary market transaction volume, Kwok said, but ‘it is still too early to call it a sustainable recovery trend’.

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‘It is still too early to call it a sustainable recovery trend’

^{Judy Kwok, Manulife Investment Management}

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Bargain hunting

Still, the attractiveness of China’s high yield bond markets beckons investors.

Yields on an ICE BofA index tracking China high yield companies moved higher to about 20% at end March, having dropped to around 16% in February. ‘Investors are very interested in the China high yield bond market given its attractive relative value, but some international investors are cautious given the remaining fundamental weaknesses,’ said Manulife IM’s Kwok. China’s reopening remained a major investment theme this year even as global headwinds persisted, she said.

As for PineBridge’s Slim, he noted more investor interest for the Asian high yield sector coming out of Europe, with investors dipping their toes back into the market, possibly because of having ‘quite a bit of ammunition’.

‘The frank reality is that some investors have been burned, particularly in this part of the world. These folks are not likely to be engaged with the market quickly because it has left a bitter taste in the mouth,’ Slim said.

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‘The frank reality is that some investors have been burned. These folks are not likely to be engaged with the market quickly, because it left a bitter taste in the mouth’

^{Omar Slim, PineBridge}

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Macau’s revival

Within the broader Asian high yield bond market, as investors seek exposure beyond Chinese junk debt, an area recapturing attention is the beaten-down Macau gaming bond sector. ‘It offers good value because some overhang by licensing [concerns] is completely cleared, while [serving as] a good diversifier,’ said Freddy Wong, head of Asia Pacific fixed income at Invesco.

Macau’s gaming revenue surged to a three-year high in March as the city enjoyed a resurgence of tourists from the mainland. Local authorities had in November renewed licences for six incumbent operators in exchange for investments into non-gaming sectors as part of Macau’s tighter regulatory oversight of gambling.

‘The whole industry relies not just on gambling, but also on tourism. [Macau gaming names] have a healthy financial profile with a high level of interest coverage ratio,’ said Wong, while noting the high-end VIP segment remains lacking.

Manulife IM’s Kwok sees good value in Macau gaming bonds too, but expects it will take one or two years for credit fundamentals to fully recover.