Is Evergrande’s crisis having a spillover effect on China’s bond market? We discussed the issue as well as recent trends and current investment opportunities for investors in China’s bond market with Rob Drijkoningen, Managing Director and Co-Head of Emerging Markets Debt at Neuberger Berman.
AsiaFundManagers.com: The Evergrande case in China is keeping the financial markets busy. How strong are the echoes and what are the consequences for the Chinese bond market?
Rob Drijkoningen: There are implications for the name, sector and Chinese economy. It is now clear that even large names no longer have protection due to their systemic importance. While we see certain spillover risks in the high yield rated part of the market, in the larger investment-grade rated market credit spreads have been stable as risk aversion has driven a flight to quality.
AsiaFundManagers.com: The Chinese government is focusing on regulating the real estate market. What does this mean for the growth prospects of Chinese real estate companies, one of the most important bond issuers in China?
Rob Drijkoningen: Given the emphasis on deleveraging the real estate sector (3 red lines policy plus the target ratios for banks’ max exposure to real estate) the growth prospects of the real estate sector are clearly curtailed; this is another way of saying firms cannot do much borrowing to fund growth. While growth prospects are curtailed we believe the growth going forward will also be more sustainable. During this transition, weaker companies will be eliminated, while better-managed companies with strong balance sheet will emerge stronger.
AsiaFundManagers.com: Yields on Chinese junk bonds are at a historic 10-year high. What does that say about the current state of the market?
Rob Drijkoningen: It reminds us that there is a lot of uncertainty about what the government will do to avoid this spreading out more to the sector at large affecting growth more materially. There are shared dependencies on the willingness and ability to provide mortgages to provide funding to real estate companies; the liquidity squeeze on real estate companies is affecting the ability of local governments to auction off the land for development purposes already materially. The rise in yields also does reflect a higher risk of defaults in particular for Evergrande which is the largest issuer in the sector, and similar risks in different shapes and forms that are represented across other names in the sector. However, for some higher quality issuers, we believe that the selloff is overdone and partly reflects weak risk sentiment and the risk of wider spillover to the rest of the sector.
AsiaFundManagers.com: High bond spreads and historically high-interest rates – should we expect increased defaults in China in the near future?
Rob Drijkoningen: Yes, the year-to-date default rate for the Asian High Yield market is 2.3% and we expect defaults to rise to 9% in the region, mainly due to the rise in Chinese property defaults and with 5.2% contributed by Evergrande.
AsiaFundManagers.com: How long will it take for the Chinese bond market to return to normal?
Rob Drijkoningen: Once the government announces meaningful policies to provide guidance for Evergrande’s activities to be continued, to primarily protect prospective homebuyers, the sub-contractors, the salaries due. We think that the current dislocations in the Chinese High Yield bond market will then return to a more normal state soon, but also expect some structural changes in this market with stronger credit differentiation, which ultimately is a positive step in the development of the Chinese credit markets.
AsiaFundManagers.com: How attractive are China bonds in the current market phase? Where do you see investment opportunities in this environment?
Rob Drijkoningen: Due to the slowdown in economic growth which was happening already the safest credits with long duration are appealing the most at the moment; if and when credible policy measures are sinking in plus potential monetary easing coming through the risk appetite for lower-rated credits including real estate could well return. In addition, we believe that select BB-rated Chinese property credits are oversold and are already looking attractive.
AsiaFundManagers.com: Thank you very much for the interview.
Managing Director, Co-Head of Emerging Markets Debt
Rob Drijkoningen, Managing Director, joined Neuberger Berman in 2013. He is a Co-Head of the Emerging Markets Debt team and Senior Portfolio Manager responsible for over $24.5 bn in AuM in EMD and 34 investment professionals at Neuberger Berman. Rob joined the firm after working at ING Investment Management for almost 18 years.