Roundtable: Covid-19 hits China high yield, but real estate stays resilient

The Covid-19 coronavirus has unleashed huge volatility in international markets, pushing down bond and equity prices and making primary issuance difficult to get off the ground. China's once-buoyant high yield dollar bond market has been brought to a standstill, raising inevitable questions about the future for the country's issuers.

But there are reasons to be optimistic about the sector. Secondary prices have held up, defaults have largely been avoided and China’s government has won plaudits for its response to the crisis. GlobalCapital and Standard Chartered hosted a well-timed virtual roundtable in mid-April to discuss the challenges China's high yield issuers have faced since the start of the year — and those they will have to contend with for the rest of the year.

This will be the first in a series of roundtables to take place over the course of 2020. GlobalCapital and Standard Chartered will reconvene to discuss the high yield market in the coming months as Chinese bond issuers take stock of the impact of the Covid-19 pandemic ─ and prepare to move forward.

Participants in the inaugural roundtable were:

Kenny Chan, chief financial officer, Zhenro Properties Group

Adrian Cheng, senior director, Asia Pacific corporates, Fitch Ratings

Simon Cooke, portfolio manager, emerging markets, Insight Investment

Eugene Fung, senior portfolio manager, head of credit and equities, BFAM Partners

Lawrence Leung, head of capital markets and investor relations, Cifi Holdings (Group) Co

Gerhard Radtke, partner, Davis Polk & Wardwell

Fredric Teng, head of high yield, capital markets, Greater China and North Asia, Standard Chartered

Moderator: Morgan Davis, bond editor, GlobalCapital Asia

GlobalCapital: The Covid-19 pandemic has clearly taken a toll on markets. But despite the downturn, Chinese dollar high yield bonds have remained fairly resilient in the secondary market. What is underpinning the strength of Chinese high yield compared to other segments of the market?

Fredric Teng, Standard Chartered: Late last year, we had some volatility initially associated with the US-China trade war, but the Greater China market was strong enough to shrug that off. New issue volumes were extremely strong in January and February this year. When we came back after the Chinese New Year holidays, there was even a brief period where, although people were aware that this virus was out there, deals still got done. In terms of the investor landscape, we are in a very different situation now compared to the last global financial crisis in 2008, or if we want to go further back, the Asian financial crisis in the late 1990s. In both of these previous crises, the local Asian investor base wasn't that deep in terms of liquidity. If you think about the wealth that exists now in China, Hong Kong and Singapore, this wealth is from people that make money in the region. When they are saving their money, they are investing in bond funds or in equity funds, and are very comfortable with risk being deployed in the region. There is this pool of liquidity, whether it's institutional, or state-controlled, or at the private level.

This local liquidity support was the missing piece to providing stability previously. If you go back to the last financial crisis, this pool of liquidity wasn't that deep. It was just not dominant enough to drive the market. Back in the old days, if you wanted to do a transaction, you needed to be in 144A format, because you needed the participation of US investors. This situation still exists for Indian and Indonesian credits. Unlike the Greater China market, they don't benefit as much from this local pool of liquidity.

Gerhard Radtke, Davis Polk & Wardwell: The year was off to a strong start in China high yield, and that strong start lasted surprisingly long, notwithstanding the fact that China ran into significant Covid-19 related matters quite early on in the year. January was strong, February still saw significant volume, although lower than 2019, and we even got a couple of deals done into March. As we all know, China high yield is dominated by real estate. Well above 50% of issuance comes from that sector. My feeling is that it's maybe not a bad thing in this situation because real estate companies in some ways may be more resilient than other sectors. Their business has always relied on a choppy project cycle. They can go for a while by deferring projects, by managing costs, by not having the volume every month that an industrial name, which operates at a lower margin, may need. So my sense is that these issuers are actually relatively resilient.

Additionally, because they did a lot of deals in the 2019 fourth quarter and in January and February, the property companies had front-loaded a lot of near and mid-term refinancing needs. When the crisis hit, they were in a pretty good liquidity position, having come out of a period when the market was very receptive to their issuance. Of course, there will be a lot of refinancing needs coming up, and sooner or later they will need to go back into the market, but for them it's not like it has to happen this week or it has to happen next month.

GlobalCapital: Do investors see value in the China high yield market right now? How has your view on the sector changed since the start of the year?

Eugene Fung, BFAM Partners: China high yield property is still structurally relatively cheap compared to everything else in the world. If people have dedicated money to invest in Asia, it's one of the best performing sectors.

For real estate companies, there are proper ways you can go and do your due diligence. They report their contracted sales every month. There are very good data sets across the whole sector that you can actually vet and take out. A lot of these companies have a long history of repayment and refinancing, so all that lends comfort to investors.

But if you look at the China industrial space, depending on the kind of credit you are, most of the time it's very tough to get offshore financing these days. If you look at Indonesia or India, in the last 12 months alone, we've had two or three bonds that look like they're not even going to make their first coupon.

The liquidity in China is better. We definitely saw volatility for those two and a half weeks in March, but even then, while you would have names like Sunac that would move 20 points during the day, at the end of the day it would recover somewhat and now it's close to unchanged.

At a certain price, there are buyers of bonds that will want China real estate cheap enough. Whereas if you look at the Indonesia space or India space, you just don't have dedicated investors who come out and say "oh I'll put my hand up”. People are a lot more scared of potential fraud outside of the China property sector.

Simon Cooke, Insight Investment: If you wind back to January, many investors recognised that China property was a very attractive place. It’s why we saw a wave of supply taken down with ease by the market, partly because of valuations, partly because of improving technicals, and partly because of improving fundamentals, with more prudent growth financing constrained by tighter regulatory quotas. There was an alignment of interests at the start of the year.

That was not the case for Chinese industrials. We have been extremely cautious there for a number of years. You have now seen the reason why. The industrial space includes some really vulnerable names, both smaller issuers and less strategically important issuers, with thin operating margins and weak business models. Over the winter, a number of those issuers defaulted, including some major issuers who began restructuring processes. 

At the start of the year, the real estate space was especially attractive. Fast forward to now, and what's changed? Our view on industrials is even more negative, understandably so given the pandemic. Our view on Chinese property is that the largest players are mostly pre-funded. Their liquidity positions are taken care of.

We've also been encouraged by their level of communication. The names we're involved in in the Chinese real estate space have been very proactive in terms of their communication with investors. We have had weekly calls with many of them, if not more frequently than that. They have kept us up to date on their liquidity position, what has been the impact on operations, whether they are able to roll over the debt that is falling due. Obviously, our views have changed because of the pandemic, and the impact that it is having on not just China but the entire globe, but we have been relatively encouraged in terms of the response, particularly in Chinese property.

GlobalCapital: It sounds like you see a fair amount of value in the real estate sector. Where are the opportunities right now?

Cooke, Insight Investment: China high yield initially retraced much faster than other markets. There is definitely still value in Chinese property. The big names that we invest in are well run, have decent governance compared to their peers, and have decent liquidity and access to markets, having pre-funded 2020 maturities. We feel they have managed the crisis well so far. They are an attractive proposition because they are focused on protecting their balance sheets and maintaining liquidity. They look favourable within the China high yield space but also, more broadly, globally. There are names that we think should generate healthy double-digit returns over the next 12 months. But we think there will be a divergence.

No question, we expect defaults to rise. Those particularly small names in the property space, that we wouldn’t even look at due to credit concerns, may be at risk. So too those weak industrial names that may finally be consumed by the pandemic.

We find two areas exceptionally compelling. One is dislocated issuers — those defensive businesses relatively unaffected by the pandemic, but that have sold off significantly.

Then there are those issuers impacted by coronavirus, but able to withstand it, offering a strong recovery trade. In light of the savage market sell-off, there is probably a once in a decade opportunity for the fundamental, value investor.

GlobalCapital: It is more important than ever for issuers to clearly communicate with investors. For the issuers on the panel: how have your interactions with investors changed since the start of the pandemic?

Kenny Chan, Zhenro Properties: Zhenro has been very proactive in the market. We have a very strong investor relations team. We send messages to our investors, banks and credit agencies on a monthly basis. Back in January when the virus happened in China, we immediately organised calls with investors because many of our sales centres were forced to close and our construction sites were supposed to shut down. We immediately talked to investors and told them what was happening and what we were going to do. Right after Chinese New Year, we also organised calls with global investors. Overall, the transparency is good, and you can see our secondary bond prices are standing quite firm. A proactive dialogue is quite essential.

I've been working in this industry for over 10 years and I've personally experienced three cycles. Ten years ago, if your land bank was big enough it would be an advantage. But right now, if you still want to keep a huge land bank, it may not be a positive for credit investors or equity investors. I don’t think the land value will shoot up because of the price cap and as the government has purchasing restrictions. If your funding cost is high and if you chose to keep more land bank, your margins will deteriorate.

Zhenro has made a decision not to keep a land bank for more than three years so we can maintain a fast asset turnover. The funding cost for Zhenro two or three years ago was high. Right now, it is relatively low. We don't want to keep investment properties; we just want to build and sell. We focus on tier two cities. It makes sense for us because there is a solid demand in tier two and land premium is relatively lower than tier one.

Lawrence Leung, Cifi Holdings: Because investors have a lot of bonds in their portfolios, when the market faces disruptions they tend to send out a list of standard questions. The most common questions would be if we have any short-term maturities coming up and whether we have sufficient funds to meet those maturities, so I get everyone’s concern on short-term liquidity.

Back in February, when the virus was starting to be more severe, we explained to our investors how we managed liquidity. They become more comfortable when they see us giving them a weekly update on how we manage to do business during lockdown and how we will resume our business when the situation stabilises. Frankly, we have not got a lot of company specific inquiries, and recently the pressure has been more focused on the physical market and how property sales are going, and if there will be any policy changes.

GlobalCapital: It sounds like transparency is one of the key factors keeping this market moving. What kinds of steps are other borrowers taking?

Fung, BFAM Partners: There are a lot of CFOs coming out and talking about their liquidity positions. There are CFOs who are conducting buybacks during this volatility. In general, they have been pretty transparent with a lot of the details they give in regards to their contracted sales and their liability numbers. It's just a matter of if you want to do the leg work and verify those numbers. But we definitely saw a number of companies being very proactive and telling people their liquidity positions and saying, ‘hey if we don't sell another apartment for the next six months, this is how much liquidity leeway we would still have’. Issuers have short dated bonds they are buying back just because they think it is opportunistic to do so. All that is a good sign because it does comfort people that companies have the ability to step up during volatile times.

It's a function of the fact that most of the CFOs in the sector are pretty experienced, and they took advantage of the fourth quarter and early first quarter windows to do a lot of refinancing. In some sense, we don't have any kind of short term maturities until later on in the summer, and the third and fourth quarters.

Cooke, Insight Investment: The key thing is that there has been a multiplication in intensity, and that has not just been in China high yield. Worldwide, the pandemic has required a huge increase in interactions with issuers. We need to know how they are managing the crisis, how much cash they have, how quickly that cash is being drained, are they able to still generate any cash flow from sales, what has been the impact on operations from the coronavirus, and how they are dealing with upcoming maturities.

It's one of the ways that this crisis is different to other recent crises. We are not just talking about a fall in economic activity. For some issuers, we’re talking about zero economic activity. They cannot sell anything. Do they have sufficient cash, sufficient facilities and sufficient support to manage through this period? 

That is what has been required from issuers, globally, not just in China: regular, transparent communication, weekly if not more frequently. The encouraging thing is that the bulk of them have stepped up, being very responsive.  We do see a link, speaking of China, that those issuers with a Hong Kong listing are generally more proactive in talking to investors. We think that’s partially due to the higher levels of transparency required for a Hong Kong listing, so they’re more used to it.  

GlobalCapital: This must change the interactions between the banks and borrowers as well. Fred, how have your client relationships changed? What have issuers been up to recently in terms of capital markets activities and investor relations?

Teng, Standard Chartered: We have to look at each issuer's specific circumstance. The starting point is if they need immediate liquidity or not. By and large, the more established players, like Cifi and Zhenro, planned ahead and pretty much pre-funded for the first half of this year. They also have multiple channels of liquidity, and having that diversification adds to the strength of these credits. And you have to go back to fundamentals. There's only so much you can do in the capital markets. The physical demand for China property is there. There is pent up demand in the physical market. It shows up in the strong sales numbers. It's real demand. If there's a collapse in the Chinese property market, then no matter how well you manage things in the capital markets, eventually you fail because there has to be a fundamental backdrop that underpins that.

If a company has liquidity, they could focus on buying back short-dated bonds. If I have a bond that is maturing in six months to a year anyway, it's not speculation. I was going to pay it back at par and this thing is now trading at 90, so let's see if I can buy some. And it helps normalise the curve.

Onshore bond market liquidity can be quite cyclical as investors there are mostly total return driven and not relative value driven. Banks are the dominant investor base so it behaves like a semi loan market. The investor base is not as diversified. In the offshore bond market, we have dedicated relative value investors who are focused on investing in high yield bonds. When the market goes up, they need to invest, and if the market goes down, they [still] need to invest. The question is the positioning — how much to buy and what duration. A large developer would need to diversify its sources of liquidity. They would have to maximise their funding channels and diversify.

For issuers, one attraction of the offshore bond market has been that traditionally the use of proceeds is much more flexible. The other benefit is the duration of the funding you can achieve. The duration and depth in the onshore bond market are limited and inconsistent.

GlobalCapital: Is there a growing concern about defaults or refinancing risk for some property companies?

Adrian Cheng, Fitch Ratings: From most developers, liquidity in a way has been better since Covid-19, because onshore liquidity appears to have loosened. Having said that, on the offshore front, you have seen bond prices tanking for quite a few developers, which does not seem to be related to the fundamentals of these homebuilders, but more to do with market reaction for flight to safety.

Liquidity is a key focus for us, especially for single B rated players. We ask them for regular updates on refinancing plans. The larger homebuilders have diversified funding sources, and would have had frequent access to markets. We are not worried about them. Even if they have capital market maturities this year, they would have pre-funded it long ago.

It's really the single B players that haven’t been in the dollar market much, but have dollar bonds outstanding and maturing soon. If a company now has to depend on market conditions to refinance, then there is a higher risk that they can't refinance.

GlobalCapital: Pandemic aside, then, how do issuers decide what part of the capital market to tap when they are seeking funding? In particular, what is the appeal of the offshore bond market?

Chan, Zhenro Properties: In my almost nine years as a CFO, I've always believed that diversification of funding channels is very important, especially to property developers. When the government wants to cool down the market, they go directly to the funding channels. Once they tighten the liquidity in the overall funding channels, it will cause developers some problems. I see some smaller guys failing to repay. I see some bigger players having to print at a higher cost. We cannot just focus on one particular market, nor can we have a high concentration on any one funding channel.

For rating agencies, it also feels safe. No matter loans or bonds, I think the diversification of funding channels is very important. If you compare apples to apples of a three year loan deal and a three year bond deal, my interest savings is two points to three points when I go to the loan market. But there's no free lunch. When I go to the loan market, the financial confidence of the loan market is very demanding. It looks cheap, but the covenants are very demanding. The loan market, compared to the bond market, gives us better flexibility for using the proceeds. For the bond market, the regulators are still quite firm that funding must be for refinancing purposes only.

Radtke, Davis Polk & Wardwell: The use of proceeds, and the flexibility that came with that, was initially a big driver for why real estate companies looked at the offshore market. They could raise financing in the onshore loan market up to a certain percentage of their leverage needs, and offshore they could essentially borrow the additional amount for the equity seeding capital for their expansion projects. Onshore they got the loans, and offshore they could raise another layer to really grow.

Over time, the regulators have aimed to rein in and limit the role of offshore leverage the sector takes on and, right now, the real estate issuers are essentially limited to refinancing their outstanding offshore high yield bonds. They cannot really use that right now to grow. And notwithstanding this current crisis, we have not seen the regulators really moving away from that more restrictive attitude.

We see the regulators being proactive and fast, but I haven't yet seen them approve expansion funding for real estate companies. In other spaces, like the industrial sector, there certainly are a lot of industrial companies working on projects and expecting and looking forward to the market reopening. For them, the limitations do not apply, so they can raise bonds with wide flexibility of use of proceeds.

GlobalCapital: One of the themes that consistently comes up in conversations is the effort of the Chinese government to keep its capital markets open, and the economy moving, amid Covid-19. The country's efforts stand out. How have China's stimulus initiatives supported the market and comforted investors?

Chan, Zhenro Properties: Let us look back to February, when the outbreak was very serious in China. Even though liquidity was strong at that time, the number of visitors to our sale centres was cut almost 70%-80% because many of the sale centres were closed and people were not very willing to buy. In February, the situation was mainly a matter of confidence. But right now we can see the China market, and the Chinese government, trying to resolve these problems seriously and doing the right thing to control the virus. I can see the willingness to buy and the willingness to visit a project have picked up a lot, especially in the third week of March. If you see our sales data in March, it picked up over 90%.

If you look at the stimulus measures, they are mainly focused on liquidity on the loan side. For home purchase restrictions or first-time deposit restrictions, some local governments are willing to revise or revisit the restrictions. But that it is less likely to have [a major impact] because it will go against the central government policies, as the central government still wants to cool down the market.

Fung, BFAM Partners: The government hasn’t done a lot to target the property sector. I think they have purposefully stayed away from that since 2014. But if needed, they would act.

They have shown that they have a couple of things going for them. They haven't had to do a lot of physical stimulus. They have done it through monetary measures, through RRR cuts, and have done it through directing banks to do what needs to be done.

The one thing that separates China from the Western world is that [the government] can tell the banks exactly what to do and where to lend, and just recapitalise the banks because they own the biggest banks anyway. On the other hand, in the West, they are going out of their way to try to support companies and the economy and not be seen as supporting the banks, just as a remnant of 2008. That makes them pretty inefficient. It's a lot smoother and a lot more targeted in China. That is something I've noticed and that gives me comfort. If they see certain sectors that they need to support, they would be able to do it.

Radtke, Davis Polk & Wardwell: One thing that is remarkable is the wide divergence you saw between the yields that the offshore high yield bonds attracted and the comparable yields offered onshore at the same time. For some of these real estate names, you had the offshore bonds trading somewhere in the 20% yield range while the onshore bonds were trading below 5%. That in many ways illustrates structural differences. But the other significant point it illustrates is the great lengths to which Chinese regulators have gone to provide liquidity to the market and also to the issuers, more or less directly, through the banking system. There really has been a flood of liquidity that has been released onshore.

Now how does that benefit offshore dollar high yield bonds? It is an indirect impact. It can help the companies get through this and that is probably the most important thing. It can also, for a moment in time, reduce the appeal of the offshore markets because if liquidity is really cheap onshore, they'll do everything they can to try to utilise that. In some sense, it reminds me of a phase four or five years back when the onshore bond market first became really accessible and attractive for real estate companies, and all of a sudden there was a silent quarter or two in the offshore market.

On the other hand, issuers have seen — very drastically — how quickly funding routes can shut down. In February, we were talking with a lot of issuers that typically may not want to raise offshore debt that thought ‘oh maybe we should do that to diversify our funding methods’. In the medium-term, issuers will pick that up again, even if right now there is plenty of liquidity provided onshore. Issuers will remember that there was a period when everything was shut down, and being able to relatively quickly shift to another market can be a very valuable tool for many of them.

GlobalCapital: Where does that leave issuers?

Leung, Cifi Holdings: We have been operating under this highly regulated environment for a long time and liquidity, in general, is tight. It is pretty clear that the government does not want to create a property bubble. The logic behind this is that housing is designated for accommodation; it is not for speculation.

Having said that, we have seen favourable changes recently, particularly in the onshore bond market. We recently had a bond puttable to us and the original investors actually agreed to hold on to the bonds at a lower rate for two more years. So it is pretty clear that we should be able to get lower interest rates going forward in China. Whether it would be favourable or not to developers, it really depends on the positioning of the developers — if they are financially stable, if they have good working relationships with the banks, if they have a good track record in the capital markets, it is very likely they will see their funding costs come down.

For the highly-geared companies and those facing a lot of short-dated debt maturity, there are probably a lot of challenges ahead. In particular, if you look into offshore bonds, although we have recently seen a significant recovery, it is challenging for weaker credits to come to the market and raise funds at the moment. That is why we believe we have to manage short-dated liabilities very diligently because when the market is shut, when liquidity is out, it will be very hard to get funding to refinance short-dated debt.

Cheng, Fitch Ratings: We did hear from some homebuilders that regulators may be loosening some restrictions on offshore bond financing. It is an interesting move if it is true. It shows that when things go too badly for the homebuilders, the regulators are ready to step in to stabilise the market and the funding conditions for them. If you look at the fundamentals of a homebuilder and the demand for property in China, there is a lot of pent-up demand. But the policies in the past few years have been restrictive.

There are still a lot of tools for the Chinese government to regulate supply and demand for this industry. I think that probably in the next two years we will still see a stable market, especially for those that are frequent issuers offshore. As this industry consolidates, these kinds of larger frequent issuers will become winners in this industry.

For liquidity, the bigger worry is in the offshore market. If the market does not recover, then they will need other sources to refinance their offshore bonds. In contrast, the onshore market faces fewer refinancing risks. Onshore liquidity is getting looser and some of the borrowings they have onshore are secured to projects. These deals can usually be rolled over quite easily.