We have turned more constructive on the China property sector due to a material dovish shift in policy in recent weeks and improving liquidity conditions. The sector accounts for 19% of the Asia high yield market1 which we are overweight as we see opportunities to generate attractive risk-adjusted returns. Still-elevated default risks in the China property sector underscores the importance of active security selection, dynamic positioning and diversification.
Authorities in China have been tightening property regulations for half a decade to address property price appreciation and potential speculation in the real estate market. However, the scope and intensity of policy tightening since last summer2 has been unprecedented. Restrictive policies cooled the housing market in 2021, as intended, but also led to tighter financial conditions, challenging the ability of highly-geared property developers, such as Evergrande, to refinance.
In an insight published in September, “Evergrande – Climbing Down the Property Ladder3”, we noted that financial market implications of a default at Evergrande would likely be confined to China, with limited global repercussions. We also outlined that the situation in the China property sector is fluid. Below we highlight three key developments that have led us to turn more constructive on the China property sector and in turn on investment opportunities in the Asia high yield market:
Macro. On December 6, the China Politburo, the principle policymaking committee of the Chinese Communist Party, set a pro-growth tone for policy in early 2022, emphasising stability and domestic demand. For example, the word “stability” appeared nine times in the Politburo meeting readout compared with three times last year. In addition, following Premier Li’s comments on lowering the reserve requirement ratio for banks to support the real economy, the People’s Bank of China announced a 50bps cut, effective December 15. Finally, the China Central Economics Works Conference concluded on December 10 and indicated support for more flexible policy at the city-level to ensure healthy development of the real estate sector.
Regulatory. The China Banking and Insurance Regulatory Commission is seeking to encourage lending to the real estate sector that is consistent with promotion of “stable and healthy developments”, requesting that mortgage demand “be satisfied as a priority”. Meanwhile, the China Securities Regulatory Commission has stated that it is committed to capital market activity that supports “the normal financing needs of real estate companies”.
1 Source: ICE-BoAML, Bloomberg, Goldman Sachs Asset Management as of November 2021.
2 In summer 2020, the government implemented “Three Red Lines” of control on property developers’ leverage. This involves three leverage thresholds: 1) a total liability to total asset ratio (excluding presales deposit) below 70%; 2) a net gearing ratio below 100% and; 3) cash to short-term debt ratio above 1X. As of June 2021, Evergrande debt / EBITDA was 20x, while net debt / total equity was 99.9%.
3 Please reach out to your Goldman Sachs Asset Management representative to access.
4 Evergrande missed coupon payments due on November 6 for two of its bonds. The company had a 30-day grace period to remedy missed payments but according to Bloomberg, the payments had not been made prior to the grace period expiry on December 6.
5 Source: Reuters, local news sources and Goldman Sachs Asset Management.
6 Source: ICE-BoAML, Bloomberg, Goldman Sachs Asset Management as of December 6, 2021.
7 Source: ICE-BoAML, Bloomberg, Goldman Sachs Asset Management as of November 30 2021.
8 We estimate $5.5 billion of bonds will mature in January, followed by a further $4.9 billion in March and $5 billion in April.