China Under the Weather (Again)

September 27, 2021

BY Milltrust International Group

In light of the current market situation in China/Hong Kong please find below a short commentary the Milltrust Global Emerging Markets investment team and from The Climate Impact Asia investment team:

The Evergrande situation:
– Evergrande is still likely to default.
– The government will likely tolerate a stand-alone bankruptcy of the company. However, they would not want to see this spiralling further leading to a loss of confidence in the banks or the broader market [Source: Xingtai].
– The most likely scenario is one where the government orchestrates the sale of Evergrande Group’s assets and projects to a group of other Chinese property developers [Source: Xingtai].
– This will likely not become systemic.
– Total outstanding bank loans to China property development space is about 10 trillion RMB.  If you look at loan loss reserves on the balance sheets of Chinese banks, it is about 5.4 trillion RMB and they may get an additional 2 trillion RMB a year [Source: Bloomberg].   So unless you assume a massive default ratio on the entire body of commercial and residential property development loans in China today, this is not a systemic risk; just the opposite, this brings up potential buying opportunities.
– The size of the Evergrande loans is only 0.15% of system-wide loans.  [Source: Bloomberg].
– The latest trading pattern of the outstanding bonds of the other Chinese property developers, all of which are trading at levels not too far from their par values, supports the view that contagion risk is limited. [Source: Xingtai].

Opportunities in China:
Clearly recent events in China, starting with the regulatory crackdown on mega caps, the unravelling of Evergrande, etc, have put a dent in foreign investor’s appetite for Chinese stocks and this may not change in the short term.  But…
– China is currently in oversold conditions
– We are likely to see a policy-driven bounce which will provide some upside for stocks; bad news (decreasing liquidity) is good news (credit impulse).
– Domestic investors dominate Chinese stock market and the factors underpinning domestic investors’ appetite remains supportive: with home prices decelerating, households are likely to invest in stocks, and underlying liquidity conditions are likely to improve.

For more information, please feel free to contact us on [email protected]

Views from The Climate Impact Asia team:
Investors have been selling down their exposure in China/Hong Kong with risk-averse sentiment being triggered by concerns that Evergrande, the world’s most indebted property developer, will not be able to honour its looming payment obligations, estimated at more than $300bn, to creditors and businesses. Markets are now fearing the possibility of default with possible contagion across the Chinese property sector and the wider domestic financial markets. 

It is unclear what the Chinese government will do despite Evergrande Property being deemed “too big to fail” and risking the possibility of a systemic risk. Until there is further clarity, we expect markets to continue to remain volatile.

As a fund focusing on the leading innovative Asia Pacific companies developing scalable solutions to enable the adaptation to or the mitigation of climate change, The Climate Impact Asia Fund (CIAF) is not exposed to Evergrande, or any associated sectors of concern, and we have already been gradually shifting the portfolio away from China over the past months. This shift has acted in favour of the fund’s performance over the past month. For more information, please feel free to contact us at [email protected].