Illustration: Aïda Amer/Axios
Since China Evergrande began flaking on debt payments in September, the world’s focus has turned from whether its collapse represents a Lehman Brothers-like moment of systemic peril (it doesn’t) — to whether China’s whole property sector is set for a string of defaults (it probably is).
Why it matters: Lehman or not, the Federal Reserve warned this week that financial fallout from China’s real estate shakeout “could pose some risks to the U.S. financial system.”
Driving the news: At least four Chinese housing developers have formally entered default for not making interest or principal payments on their dollar bonds, the Wall Street Journal reports.
The big picture: China’s government thinks developers took on way too much debt, and last year ordered domestic banks to tighten lending standards.
- Yes, but: Those lenders thawed after the Chinese central bank last month made comments that appeared to ask them to loosen up credit to prevent a property sector meltdown.
- A key meeting of the Chinese Communist Party, known as the sixth plenum, is taking place this week. Watch for whether top party officials publicly support the sector or discuss extending credit to it.
State of play: A slew of developers borrowed money in the offshore dollar-denominated bond market — but recent investor aversion has led to a massive selloff.
- Many high yield bonds issued by China-based property developers now trade at pennies on the dollar, and average yields are over 25%, per the WSJ.
- In the next two months, a hefty lineup of developers' bonds are scheduled for repayment, Aayush Sonthalia, portfolio manager for emerging markets debt at PGIM Fixed Income, tells Axios.
- “Every morning when we start the workday, the focus is on what coupons or maturities came due … and how low the bonds are trading today,” he says.
Between the lines: The trading levels make it all but impossible for these companies to refinance in the offshore market. No investor will fund new debt at 100 cents on the dollar when they could just buy similar bonds at 60 cents or lower in the secondary market.
Zoom in: Evergrande may have made a few 11th-hour interest payments, but it’s still expected to go through a debt restructuring (three more payments due Wednesday appear in doubt, Reuters reports).
- "It's headed for a default. They paid the [previous] coupons in order to buy some goodwill, and to avoid a completely unstructured default," Sonthalia adds.
The bottom line: The sector is in for a reckoning, but contagion hasn't spread to other areas of the global bond markets.
- Case in point: JPMorgan analysts forecast that the emerging market corporate bond default rate (excluding China and Argentina) will be just 1.1% in 2022, which is not too far off their forecasts for U.S. and European default rates.
Go deeper: Housing slowdown threatens China's economic muscle