APAC default risk remains high

IFR Asia 1259 - 22 Oct 2022 - 28 Oct 2022
5 min read
Emerging Markets, Asia
Jane Li

The default risk for high-yield issuers in Asia Pacific will remain elevated for the rest of the year and going into 2023, say analysts, driven by China’s property crisis as well as a slew of other unfavourable factors including rising interest rates.

Beyond property, Chinese local government financing vehicles are being closely watched because of mounting signs of credit distress.

The trailing 12-month default rate of non-financial speculative-grade companies in APAC is projected to reach 8.6% by the end of December, up from 7.5% and 7.6% in December 2021 and 2020, respectively, according to Moody’s. Overall, the default rate for high-yield credits in the region is significantly higher than the rest of the world this year, with the trailing 12-month global average rate projected to be 2.9% in December.

Many countries continue to report rising inflation, so aggressive tightening seems set to continue, which could curb companies’ funding access and increase their default risks. China, though, surprised the market in August by cutting two interest rates, as it tries to lift an economy deeply wounded by its stringent zero-Covid policy.

While the reopening of Asian economies as travel restrictions are lifted could provide a boost, that will be short-lived while higher rates across most of the region and in the US dollar funding market will continue to bite.

"It's not only about the Fed, and not only about China, but about the global economy," said Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis. "By mid next year all of the statistical impact of opening up will not be there, so I would very much worry about credit risk in Asia."

Defaults in APAC this year, like last year, have been led by Chinese property developers, which have been grappling with falling housing prices and stagnating sales. The default of CIFI Holdings on a HK$2.545bn (US$325m) convertible bond this month further exacerbated investors’ concern about the sector’s heightened default risk, given CIFI was seen as a leading developer with projects across the country. CIFI was one of the six developers given government support for their onshore bond issuance under a programme that began in August.

Clara Lau, senior vice president of ratings and process oversight at Moody’s, expects to see some defaults from Chinese property developers as it will take time for the housing market to recover. “Going into 2023, the default rate in APAC will probably remain at a high level because of expectation of slowing global economic situation. For China, while it’s not the end of the tunnel for the property sector yet, the number of defaults could have already peaked," she said.

Zerlina Zeng, a senior research analyst at CreditSights, also expects default rates among high-yield issuers in Asia ex-Japan to continue to trend upward towards year-end. In addition to default risks in China's property, investors in the region are also watching potential corporate governance issues in areas like Indian and Indonesia high yield, said Zeng. Investors have complained about the lack of transparency among some distressed issuers in the two countries, bankers said.

Beyond the property sector, other Chinese high-yield issuers are also under pressure as investors fly to quality and bond prices have been volatile, said Zeng.

LGFV stress mounts

There are also concerns about China’s local government financing vehicles, which accounted for roughly 71% of the total US dollar bonds issued by Chinese corporates this year as of early August, according to CreditSights.

They are not immune to problems in the property sector, however. As many developers struggle to repay debt, local governments' land sales revenues – their largest non-tax funding source – have plunged. This has weakened their capacity to support LGFVs and, according to analysts from research firm Rhodium Group, additional credit events at LGFVs will emerge in the months ahead.

More than 50 LGFVs defaulted on commercial acceptances, which are short-term debt instruments used to pay suppliers, in August, compared with fewer than 10 back in January, the research firm said. “The immediate rise in acceptance defaults does indicate that many LGFVs are already receiving insufficient financing cashflows to repay their debts,” wrote the analysts.

A further problem for international investors is that many of the LGFVs that came offshore this year are those with weaker credit quality which struggled to get funding onshore.

“It really depends on policy direction for local governments to support LGFVs and how the LGFVs manage their financing. Vehicles with large engagement in commercial business but weak business and/or credit fundamentals are less likely be supported and will face higher refinancing risk,” Moody's Lau said.

But LGFV defaults on public bonds look unlikely in the next six to nine months due to government support, said Zeng.