Asia Junk Bond Giant Is Threatening Already Fragile Markets

(Bloomberg) -- A stumble by Asia’s biggest junk bond issuer is threatening broader pain across markets that had already been weakening in recent weeks.

China Evergrande Group warned Chinese officials it could face a potential default in a letter in August, according to reports Thursday. The news adds to broader risks that have flared this month as investors assess the pandemic’s impact on the global economy.

Asian dollar bonds sold off and were set for their worst week since March. Shares of home-related companies fell in China, where equity indexes had already been among Asia’s biggest decliners this month.

Direct exposure to Evergrande’s bonds alone would be a major blow to investors but the systemic hit could be far larger given the concentration of property bonds in portfolios, according to Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group Ltd. in Singapore.

Bonds from Evergrande and other Chinese developers slid further Friday. The company has said that online social media posts about its asset restructuring plans are “made up” without specifying details.

“For the broader market, in the near term, investors may think China property is a higher-risk sector,” said Raymond Cheng, an analyst at CGS-CIMB Securities. A repeat of the kind of sell-off seen in March as the pandemic spread is unlikely in part given ample market liquidity, he said.

Developer Debt

Still, the sheer scale of Evergrande’s borrowings is fueling concern. The group is the biggest corporate issuer of junk dollar bonds in Asia, having sold more than $24 billion in the past five years, according to data compiled by Bloomberg. And it accounts for about 7% of outstanding junk dollar notes sold by companies in the region outside Japan.

More real estate companies have been teetering under large debt loads as the Covid-19 crisis hurts sales.

In India, a cash crunch among shadow banks left developers struggling to complete half built projects. Earlier in the year, Lodha Developers International Ltd. skirted a default after a rating downgrade.

In Indonesia, property firms face record maturities next quarter, just as they grapple with new pandemic restrictions. Developer PT Modernland Realty already missed a bond coupon deadline earlier this month.

And at home in China, Evergrande’s warning of a looming cash crunch adds to strains for the sector. Shares of real estate owners and developers have slumped about 8% this month, according to a Bloomberg index, more than the 5% decline for a broader index of Chinese equities.

Signs that the country’s policy makers are looking to curb borrowing in the sector including tightening access to credit in a “three-red-line” policy is adding uncertainty. The policy restricts bank borrowing according to three financial ratios, S&P Global Ratings has said. Sales of developer dollar notes have already sunk to a four-month low this month.

The sell-off in Evergrande’s bonds “will have wider ramifications for Chinese property bonds specifically and Asian high-yield generally,” said Charles Macgregor, head of Asia at Lucror Analytics. “This will bring a period of reflection by investors with some fund redemptions leading to bond sales and, more importantly, adversely impacting on market liquidity.”

By Rebecca Choong Wilkins

--With assistance from Denise Wee, Ina Zhou, Moxy Ying, Finbarr Flynn and Kevin Kingsbury.