China Developer Distress Builds, Clouding Junk Bond Rebound

Chinese junk dollar bonds have rallied in recent weeks off their lowest levels this year, after policymakers ramped up supportive steps for the property sector and Country Garden Holdings Inc. averted potential default.

High-yield notes have posted three-straight weekly gains, the first such streak since June according to a Bloomberg index. But even after that, average prices are solidly in distressed territory at 67 cents on the dollar.

The market’s shock in August, when Country Garden missed initial due dates on interest payments, is still fresh on traders’ minds. The possibility that the country’s former top builder by sales could join the sector’s list of defaulters rocked the nation’s credit market and pushed up offshore stress to a three-month high of level 4 from 3 in Bloomberg’s China Credit Tracker. The gauge indicates rising levels of financial strain via a band from 1 to 6.

Developers still make up most offshore defaults by Chinese bond issuers, and missed payments continue to climb. Delinquencies by all borrowers have topped $40 billion and are running ahead of 2022’s record pace, according to data compiled by Bloomberg. Meanwhile, extension proposals involving yuan notes are increasingly facing creditor opposition.

Country Garden seeking to extend onshore debt indicated “a bearish turning point” for China’s property sector, Nigel Foo, head of Asia fixed income at First Sentier Investors, wrote in a research note. His team, which Foo said has been staunch supporters of the industry, has turned more defensive. That includes cutting positions of “higher-beta China exposures given the possible secondary impact from the risk-off sentiment in the market,” according to Foo.

Country Garden, which earlier this month paid two dollar note coupons just before a grace period ended, has obtained investor approval to stretch principal payments on eight yuan bonds over three years. The extensions give the developer time to generate cash while revenue plunges. Its contracted sales fell 72% from a year earlier in August, after dropping 60% in July and 54% in June, roughly double the declines that China’s largest builders have suffered.

Onshore, Bloomberg’s credit tracker shows stress eased for a second-straight month in August, dropping to level 3 from 4. Demand surged for shorter-term yuan notes from local government financing vehicles, led by lower-rated borrowers, in the wake of China’s efforts to stem debt risks in the sector. Meanwhile, defaults for onshore bonds overall fell to their lowest since May and premiums continued to narrow for medium-term corporate notes, Bloomberg-compiled data show.

But those spreads have widened in September, as yields jumped from 2023 lows alongside selling of Chinese sovereign bonds attributed to dwindling liquidity and waning bets for broad monetary policy easing.

China’s latest moves to bolster housing demand included cutting down-payment requirements. Beijing and Shanghai subsequently registered a surge in deal activity, but that quickly slowed in some major cities. A pop in new-home demand earlier this year after a prior series of property support steps didn’t last, and some analysts had cautioned the latest bounce could face the same fate.

New-home sales provide builders with critical cash flow to fund construction and debt servicing. The industry’s liquidity crunch and sales slump the past several years fueled offshore-debt defaults at two-thirds of the 50 biggest private-sector developers by dollar bond issuance as of Sept. 1.