China Dollar Bonds Show Least Stress Since Evergrande Meltdown

Stress in China’s $750 billion offshore dollar bond market has eased to the lowest level since China Evergrande Group’s debt woes worsened in 2021, after a raft of policy support and loosening of Covid restrictions.

Chinese offshore dollar bonds have in recent days extended one of their biggest rallies ever, after returning 6.5% in November to end 14 months of losses. Developer-dominated junk notes surged 20% last month, the biggest advance in over a decade, according to a Bloomberg index.

That all helped lower the stress gauge for the offshore market to level 4, the lowest in Bloomberg’s China credit tracker since August 2021, though still on the higher end of the band from 1 to 6.

The rare easing of stress came as Chinese regulators issued a 16-point plan to financial firms aimed to boost the real estate market, and separately loosened builders’ access to pre-sale money, a key source of funds. In addition, the country’s mega banks vowed to extend at least $179 billion of financing help to developers. Further signs that China will accelerate an exit from Covid Zero spurred bullish bets across Chinese assets that markets have bottomed.

The reaction to the policy changes has been swift. A case in point was Country Garden Holdings Co.’s dollar notes, which returned an eye-watering 404% in a month through early December, the best performer in a Bloomberg China junk dollar bond index.

“Risks of defaults have receded in the short term, and we still see scope for credit of quality developers to outperform,” said Chang Wei Liang, a macro strategist at DBS Bank Ltd.

Meanwhile, stress returned to its lowest level in the much-larger onshore credit as there have been no reports of missed payments on yuan notes. According to Bloomberg-compiled data, there’s been no month without defaults since 2018.

But domestic corporate bonds have been undergoing one of their largest selloffs ever, driven by a mix of thin liquidity in the onshore market and investors’ pivot into risk assets on optimism that China is emerging from its pandemic bubble. The average spread on China’s local three-year AAA rated corporate notes blew out the most in five years last month, and has since widened further to the worst in more than two years at 88 basis points.

The recent surge in yields, outpacing that for sovereign bonds, prompted many borrowers to shelve debt sales. Firms pulled plans to sell a combined $8.5 billion of local notes in November, nearly five times the year-earlier figure and the highest monthly level since January 2021.

Financial regulators told Evergrande to resolve its debt problems in August 2021, dashing hopes for some sort of government bailout for the property giant. The developer's first dollar-bond default occurred that December, ahead of a record year of builder-fueled offshore delinquencies in 2022.

While policy shifts have provided several financing lifelines to developers, the aid will be skewed toward higher-quality firms as the sector’s divergence continues, according to Fidelity International fixed-income portfolio manager Belinda Liao. “The winners in the space will be those that are the direct beneficiaries of the policy support,” she said.

The recent bounce in high-yield dollar notes has merely put a dent in their 2022 losses — which at 25% are poised to match last year’s record drop. New-home sales fell by a quarter from a year earlier in November, underscoring the challenge for policy makers to revive the embattled industry.

As for Evergrande, the world’s most indebted developer and the company at the center of China’s property debt crisis, it has yet to announce its long-awaited restructuring plan for more than $270 billion in debt.