Riskier Chinese Property Bonds Suffer as Evergrande Struggles

Selloff has sharpened the distinction between companies perceived as financially stronger and those where investors have concerns

Published 12 September 2021 7:03 am ET

Bonds from lower-rated Chinese property developers have fallen steeply in price after warnings of a potential default at industry giant China Evergrande Group EGRNF 1.33% sent investors scrambling to protect themselves against trouble elsewhere in their portfolios.

Various dollar bonds due in 2023 and 2024 from Fantasia Holdings Group Co. and Guangzhou R&F Properties Co. have fallen to less than 60 cents on the dollar, pushing yields on most of these debts above 40%.

Fantasia, Guangzhou R&F and others, like Evergrande, are trying to adapt to a tougher new regime under which Chinese authorities are pushing developers to cut debt, partly by forcing them to fall into line with a series of leverage limits known as the “three red lines.”

The recent selloff has sharpened the distinction between companies perceived as financially stronger and those where investors have concerns about borrowers’ ability to repay or refinance dollar bonds that are coming due in the next year or so. The market moves themselves add to the challenges, because they could make it much harder, or impossible, for borrowers to issue new debt at reasonable interest rates.

“Investors saw one of the largest property developers go through a vicious cycle that resulted in difficulties in debt refinancing and are now worried that other weak developers may struggle to survive,” said Iris Chen, a credit analyst at Nomura.

Ms. Chen said risk appetite remains fragile, putting pressure on the weaker developers. “This may result in more distress cases,” she said.

Chinese property debt makes up a large chunk of Asia’s high-yield bond market and until recently was popular with international investors. These buyers were attracted by the combination of high returns—yields often topped 10%—and the sector’s economic importance to China, which many believed meant lower investment risk.

However, this year has challenged that assumption. As a result, the extra returns investors demand to hold Chinese high-yield dollar bonds instead of U.S. equivalents, have soared, with that spread widening to about 9.4 percentage points as of Thursday, up from about 4.8 percentage points three months earlier, according to ICE BofA indexes.

Evergrande said on Aug. 31 that work has been suspended on some real-estate projects after it delayed payments to its suppliers and contractors, and warned for the first time that it may default on its borrowings if it can’t resolve its liquidity problems. Earlier this month, both Moody’s Investors Service and Fitch Ratings cut their credit ratings on the company deeper into sub-investment grade.

The company has dollar bonds due each year from 2022 to 2025. As of Friday afternoon in Hong Kong, the longest-dated of those bonds was quoted at 28.9 cents on the dollar, according to Tradeweb, down from nearly 80 cents at the end of May. The bond has a yield of about 55%.

Bonds from Fantasia due in March 2024 have dropped and were bid at 48.7 cents on the dollar on Friday, according to Tradeweb. Dollar bonds from China South City Holdings Ltd. , Guangzhou R&F and Xinyuan Real Estate Co. are also trading at levels indicating a high probability of default, Tradeweb data show, with yields in some cases above 50%.

All four companies are graded single-B by S&P Global Ratings and have similar assessments from other credit-rating companies. The ratings firms have either cut their ratings, or lowered their outlook on the debt indicating a future downgrade is possible, citing potential difficulties repaying debt due this year and next amid volatile market conditions.

Fantasia created extra uncertainty for bondholders in late August, when it told investors it would refinance a $250 million bond due in December with a mixture of its own funds and asset sales, said Chuanyi Zhou, a credit analyst at Lucror Analytics.

At the same time, developers with slightly stronger ratings have fared better, even if they are still deemed to be sub-investment-grade. Investors say they prefer companies that have shown they can cut leverage and can still issue international bonds to refinance debt coming due soon.

“There has been significant divergence of Chinese high-yield property bonds’ performance year to date,” said Jenny Zeng, co-head of Asia Pacific fixed income at AllianceBernstein.

For example, bond prices have remained relatively stable for companies such as Country Garden Holdings Co. , Logan Group Co. , Cifi Holdings Group Co. and Yanlord Land Group Ltd. All four have double-B credit ratings from S&P, placing them not far below investment-grade. Country Garden’s $350 million 5.625% bond due in 2026 was bid at 109 cents on the dollar on Friday, according to Tradeweb, giving it a yield of about 3.66%.

Despite recent volatility, picking bonds from good developers could still yield decent returns, said Alan Siow, a fixed-income portfolio manager at Ninety One who invests in global emerging-market corporate bonds.

Mr. Siow said he is focusing on company fundamentals and paying attention to financial results, as well as whether a developer is able to address market concerns. “We may see some volatility, but companies do not go bust for no reason, especially good ones,” he said.

By Frances Yoon