Hang Seng Down on Property Sector Troubles

At the time of writing (3pm HKT), Hang Seng Index is down 3.46% on Monday (Sep 20) trading. The Hang Seng Property Index dropped nearly 7% to a 52-week low. Markets in Mainland China, Japan and South Korea are closed due to public holiday.

Hang Seng Index led losses among the Asia Pacific markets, led by the continued volatility in the property sector. This is likely due to China Evergrande’s troubles seeing a broader spillover.

However, policymakers are actively managing credit risk in the property sector, with broader easing likely amid growth slowdowns.

The Ministry of Housing and Urban Rural Development (MUHRD) appears to have taken over the management of the Evergrande situation and informed some lenders on the week of Sep 13 that interest payments would not be made. This is consistent with earlier regulatory approval for the company to renegotiate with lenders. MOHURD’s involvement signals that priority may be given to financing suppliers and contractors to complete projects, so as to avoid large social events from those who have brought properties at sale.

The second priority is likely to be the investors in wealth management products (WMPs). To this end, Evergrande plans to let retail investors bid on discounted properties to repay billions in overdue WMPs, as the developer seeks to preserve cash. The company plans to organize an online property sale event by September 30 for investors who opt for discounted property in lieu of cash. The company is offering significant discounts (28% for residential, 46% for offices and 52% for stores and parking units) to push this repayment option.

It is unclear yet what this means for bondholders. Offshore bonds remained in range, pricing in 25-30% recovery from default as of Sep 17. The spillover is becoming more visible to the China’s high yield property credits, even to some with manageable leverage. As a result, financial systematic risks are rising. But Citi analysts believe these risks remain manageable because they are caused by credit tightening policies, and easier credit would help to contain the situation.

Policy Support for Credit Market

As China’s growth has notably slowed down in August and have little hope of natural rebound in September due to tighter pandemic restrictions, broader policy support is becoming more likely. The PBOC on September 17 injected CNY90 billion into the system via reverse repos to address the liquidity issues in the credit market, as well as upcoming end of quarter.

The market is clearly highly sensitive to China headlines after the tumultuous few months of regulatory tightening. But Citi analysts continue to believe that as growth slows, policy stance would shift towards maintaining stability. Even though common prosperity is a top priority, it would still require relatively fast economic growth powered by financial markets.

China’s credit growth rebounded in August amid Evergrande troubles. Direct financing was the key driver, where funds raised through government and corporate bonds and domestic equities exceeded CNY1.5 trillion, or more than half of total financing for the month. While policymakers are squeezing highly levered developers, they are also encouraging the capital market to provide more financing for the rest of the economy.

Investment Implications

Although more volatility is still likely in the near term, Citi analysts continue to believe that spillover is likely to be limited to the highly levered developers and Citi analysts see opportunities in the quality names in China property credit market.