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Evergrande’s debt issues may result in aftershocks in the high yield bond market.

If you have paid attention to the financial media, you may have encountered various different posts talking about how Chinese developer Evergrande may not have enough money to service its debt.

Or that a lot of disgruntled home buyers and retail investors are mounting protests, camping out in Evergrande’s headquarters demanding repayments on overdue wealth management products.

Evergrande Group is ranked first among the real estate developers in China with revenue as high as RMB 507 billion at the start of 2021. Since then, they have fallen to second place.

Real estate is responsible for 29% of China’s economic output.

There is a strong possibility that the Evergrande group is going to default on their debt. They have almost RMB 335 billion in debt due this year.

These are bank loans and other borrowings, which made up 81% of these debts.

Rating agency Fitch has downgraded the Evergrande Group from CCC+ to CC on Sep 7. This downgrade is a rating viewed that some kind of default is probable. S&P Global also downgraded the developer.

It is no surprise that Evergrande’s debt is trading at a large discount to a dollar.

  • July 2022 bond is now trading at 28.3 yuan
  • March 2022 dollar bond is trading at 27.5 cents, which yields 500% now

Evergrande is scheduled to make an interest payment on their September 2023 dollar debt and another RMB loan next week.

Evergrande have been selling and selling their stuff but they also face a problem.

If you are well aware of their money woes, would you have confidence that they have enough resources to finish the properties they developed?

Many High Yield Bond Funds Should be Exposed to Evergrande Bonds

I received a timely update from PIMCO regarding their exposure to the Evergrande Bonds.

As of Jun 30th 2021, PIMCO’s GIS Asia High Yield Bond fund is underweight Evergrande by 0.8% versus the benchmark index (J.P. Morgan JACI Non-Investment Grade Index).

The fund’s exposure is 3.9% versus the index weightage of 4.7%.

But due to the drop in value, the 4.7% weightage in the index has gone down to 1.9% only.

PIMCO remains underweight on Evergrande and the China real estate sector. This is a big reason why the fund is doing better than the index this year.

Actually, I viewed this as a win. Unless your fund is overweight on the China real estate sector or Evergrande, the most you would suffer from this is a 4.7% loss.

It is far better to suffer a partial loss than thinking an Asian high yield bond is safe and then suddenly found out you just lost 100% of your bond allocation.

However, the danger here is that… China is such an important debt market that most Asian High Yield bonds would have held a large proportion of their debt securities in Chian real estate company bonds.

Then, this becomes a bigger issue.

The Risks Could be Systemic Across the Asia Credit Market

According to Bank of America’s analysts, Evergrande is the largest high-yield bond issuer in China, accounting for 16% of outstanding notes.

DBS says Evergrande accounts for 4% of Chinese real estate high-yields.

Fitch suspects that numerous sectors could be exposed to heightened credit risk if Evergrande defaults.

A default will reinforce the credit polarisation among homebuilders. A default could also trigger sell-offs in the high yield credit market.

This could affect the smaller banks.

Should Evergrande collapse, Bank of America thinks this would push the default rate from 3% to 14%.

High yield China bonds denominated in the dollar has gone back up from 8% in June to nearly 14% currently.

If I were to guess, the problem has to be contained.

But what is on our mind (as portfolio managers managing client’s money) is whether foreign debt holders would suffer when the Chinese government do all they can to stabilize the local debt issues.

In any case, if you are a high yield bond investor, this is the risk that you have to contend with.

The yield is high for a reason.

It is infinitely better to delegate to a manager or hold a basket of bonds rather than individual high yield (unless you REALLY know what you are doing).

If you are an investor reaching for yield during normal circumstances, chances are you would feel safe investing in the bonds of the largest real estate developer in China.

Investing in the bonds of smaller real estate developers is risky. But what are the chances of the largest developer in China defaulting on their loan?

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Ben

Friday 17th of September 2021

I wonder what what is the OAS between US HY and Asian HY now... feels like it might be a good initiation point into QL3.SI now given that the Evergrande's unstability is now priced in.

Ben

Sunday 19th of September 2021

@Kyith, yes yes

Kyith

Saturday 18th of September 2021

Hi Ben, was wondering if you are talking about the yield spread.

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