CHINESE property giant Evergrande has staved off default on the first of many payments covering some $US300 billion in debt.
But investors are still holding their breath to see whether Beijing will step in and what happens next.
Pendal’s Oliver Ge says the fallout on the domestic Chinese market would be minimal in the event of a controlled default.
Evergrande — which owns 1300 projects in 280 cities according to Bloomberg — represents a small 0.2% portion of China’s loan system, says Ge, an assistant portfolio manager with Pendal’s Bond, Income and Defensive Stratgies team.
“Right now Beijing has not been materially vocal on a rescue package, preferring instead that the company quietly sells down its assets and makes investors, suppliers and homeowners whole before quietly exiting the industry.
“But the issue is that Evergrande is unable to deliver on the ‘quietly’ part since they have no credibility in the financial system.
“No one will lend them any money. The only way they can quickly raise cash is to mark down their existing inventory of apartments.”
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Markdowns as a high as 25% have been quoted, says Ge.
But going down this path means the rest of Evergrande’s peer group would have its asset book revalued too –prompting the sell-off we’ve seen so far.
Until recently the contagion was limited to Asia and resource names such as BHP and Rio Tinto, which supply the iron ore for Chinese property projects.
Today, even with the promise of meeting bond interest payments, the risk of contagion has increased as people rotate away from equities and high-yield credit altogether, Ge says.
And the market implication for offshore USD bonds is significant.
“Right now Evergrande USD bonds are trading around 20-25c to the dollar (yuan).
“Default is almost guaranteed at those levels and other domestic peers will invariably get dragged into the sell-off.
“The current Asian high-yield default rate is around 3%. This could rise to 9% if Evergrande and its subsidiaries officially miss their debt obligations going forward.
“In lieu of a policy u-turn from the Federal Reserve, government bonds will likely thrive in this regime.”
Evergrande is just the tip of a large iceberg in China right now, says Ge.
“There is an ongoing vicious cycle that won’t stop until Beijing decides to scale back their social inequality reforms.
“Loose monetary and fiscal can help but it won’t be enough to offset existing headwinds.”
Oliver Ge is an Assistant Portfolio Manager with Pendal’s Bond, Income and Defensive Strategies (BIDS) team.
Oliver works on developing and running key quantitative investment models, and acting as trading support for the Income & Fixed Interest team. Oliver received his Bachelor of Commerce (Finance) from the University of Sydney and is also a CFA Charterholder.
Pendal’s BIDS boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.