We expect 2024 to come with additional credit deterioration and defaults for more vulnerable corporate and government issuers.
Challenging conditions ahead. Amid record-high global leverage, a trifecta of rising defaults, higher return thresholds, and more cautious lending will challenge borrowers over the next two years.
Cashflow negative entities recovered slowly. Of our sample of global corporates (mostly not rated), 9% were cashflow negative in 2022, more than twice the 2019 level, despite the post-pandemic economic rebound. Our base case expects the ratio to creep up to 10% in 2023-2024.
The ratio could jump to 13% if financing contracts by 1%. This result from our stress test reflects vulnerability due to high corporate leverage built up during the pandemic and yet-to-recover cashflows.
Dissonance between economic growth and corporate earnings. Despite a rebound in China's GDP, corporate earnings have declined. For a sample of 3,454 Chinese corporates (mostly unrated), EBITDA fell 2.7% year on year in first-half 2023.
What if Chinese corporate earnings further decline? Stress testing the sample with EBITDA declines in 2024 of 4% (mild scenario), 8% (intermediate) and 16% (severe), the sample's cash flow negative ratio (i.e., corporates with negative EBITDA or funds from operations) rose to 13% (mild), 14% (intermediate) and 16% (severe) from 12% in 2023.
Impact is uneven. The higher cash flow negative ratios should be largely manageable for banks and lenders. However, the effect varies across industries. Real estate development is worst hit with a 37% ratio (severe) from 27% in 2023.
China's property sales will track an extended L-shaped recovery, finding support at annual sales of Chinese renminbi (RMB) 10 trillion–RMB11 trillion; sales will drop about 5% in 2024.
Rounds of policy support aimed at the upper-tier cities will see these markets stabilize first; lower-tier cities are still contending with excess supply and weak demand.
The market is becoming more polarized with the state-owned developers increasingly eclipsing the private property firms; leverage at all entities will stay elevated.
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In this quarter’s episode of Capital Markets View, Ruth and Chris focus on the secondary market, how pricing appears to have stabilised, they take a look at a detailed breakdown of where the market is pricing, touch on if Direct Lending will open up to secondary trading and compare the US and European markets.
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