January 13, 2015 9:48 am
Kaisa default risks waking China property bears
Josh Noble in Hong Kong
For China’s property market bears, the default by a Hong Kong-listed developer on its US dollar bonds looks like the canary in the coal mine. More are likely to follow, they argue, as the great unravelling of the heavily indebted and chronically oversupplied sector finally gets under way.Even some of the more sanguine observers see the recent bond and loan repayment failures by Shenzhen-based Kaisa as potentially part of a broader trend in China’s property sector.
“I’m not at all surprised by this incident,” says Chi Lo, Greater China economist at BNP Paribas Investment Partners. “With the [Chinese] economy slowing and government policy direction changing, we expect [property sector] consolidation to continue. This incident is part of the consolidation process.”
However, others consider Kaisa an isolated event with political undertones that offers little insight into the sector’s true health. The most recent earnings from the company, dated June 30, showed solid sales and a healthy cash cushion on the balance sheet, making its apparent money troubles all the more difficult to fathom.
Ultimately, how Kaisa’s malaise is resolved will be key in determining whether this proves an unwelcome blip or something more sinister for investors, who have rushed to lend money to Chinese developers over the past couple of years.
Since the start of 2012, mainland property companies have borrowed more than $65bn in international bond and syndicated loan markets. The bonds themselves were typically issued by offshore subsidiaries registered in the Cayman Islands or British Virgin Islands. Such deal structures effectively leave foreign bondholders at the back of the creditor queue in the event of bankruptcy, a risk that some say investors have taken too lightly.
“All too often people have piled in,” says a law firm partner with expertise in debt restructuring, and the global hunt for yield has made some investors less discerning when it comes to deal structures.
There is some precedent — solar-panel maker Suntech became the first Chinese company to default on its offshore bonds in 2013, and is now involved in complex bankruptcy proceedings pitting domestic and overseas creditors against each other.
Kaisa, which has $2.5bn of offshore bond debt, could prove a fresh test case if the company is forced into some form of debt restructuring. The developer has already had some of its real estate assets in China frozen by the courts, and its bank accounts blocked by local lenders. On Monday night the company said it was looking for new financial advisers to help solve its current problems, which began just over a month ago with a sales ban at some of its Shenzhen properties.
The speed with which Kaisa’s woes have mounted has caught many off guard. Its shares halved in December, while its bonds have gone from trading at par to as low as 27 cents on the dollar in a matter of weeks.
Both Moody’s and Standard & Poor’s have responded with multiple rating downgrades in quick succession, yet the company itself has been slow to update investors.
“I don’t think anyone really understands why this situation has come about,” says the head of a bond trading desk in Singapore. “The quality of information coming from the company is lower than one would hope for.”
The ripples have been felt across the Chinese property sector, with bond investors gravitating towards the better-rated companies or simply reducing exposure to Chinese real estate debt altogether.
“Questions have been raised about the asset class as a whole,” says the bond desk head.
The JPMorgan Asian Credit Index (JACI) slipped into negative territory for January last week as a result of a sell-off in property debt, while the high-yield sub-index is down 2.6 per cent since the start of the year. Chinese property bonds are the biggest component of the sub-index.
Should Kaisa find a resolution that meets the demands of offshore bondholders, then the fallout might yet be limited to slightly higher risk premiums demanded by investors for similar forms of debt.
Anything more than that — such as a lasting aversion to property sector bonds as a whole — and the ramifications could prove far more damaging. Many developers have become reliant on offshore funding for their land purchases, a dependence exacerbated by a fall in sales transactions in China last year in a weak housing market.
“If there’s any contagion, if there’s a crisis of confidence, it’s just going to be a disaster,” says a partner at another law firm.
However, optimists point to a pick-up in sales at other listed developers as evidence of improving fundamentals, and emphasise the Chinese government’s desire to keep the offshore bond markets open to real estate companies.
Meanwhile, many Asian private banking clients, who have been snapping up Kaisa’s bonds, are simply betting on a white knight.
Troubles at China’s Kaisa mark watershed for offshore investors
By Saikat Chatterjee and Michelle Chen
HONG KONG (Reuters) – The specter of default hanging over China’s Kaisa Group, a property developer in seemingly reasonable financial health just two months ago, is forcing investors to rethink how they account for political risk when buying offshore Chinese corporate debt.
China’s real estate firms have made a beeline to the global offshore debt markets in recent years, lured by the relatively cheap borrowing costs compared with on the mainland.
Property companies listed in China or Hong Kong accounted for 61 percent, or $28.3 billion, of all high-yield bonds issued by Asian companies, excluding Japan and Australia, in the U.S. dollar market in 2014, according to Thomson Reuters data.
But Kaisa’s case has shown the conventional model of pricing property developers’ bonds by totting up their cash flows may no longer be sufficient in China.
Instead they need to take account of the growing risk of unexpected action by government authorities as well as taking more seriously the lack of precedence on what recourse offshore investors have over a company’s onshore assets.
That means companies are having to hold back from issuing new bonds as investors wait to see how events at Kaisa unfold, while the yields on existing bonds of property developers are pushing sharply higher.
“Kaisa’s case asks two big questions to the global investor community: How do you price in political risk when buying offshore debt of these companies and where do foreign investors stand in the hierarchy of creditors?” said a lawyer at a U.S. firm who has worked on cross-border corporate structures, but declined to be named because of the subject’s sensitivity.
Kaisa’s woes began late last year when it said government officials in the southern Chinese city of Shenzhen had unexpectedly blocked the sales of some of its property developments. That was followed by the abrupt departure of a string of executives, including its chairman, and then a missed coupon payment on one of its offshore bonds last week.
It has a 30-day grace period, starting from Jan 8, to make the interest payment or else become the first Chinese property company to default on its offshore debt.
On Tuesday, the bonds sold by Kaisa in the so-called “dim sum” market were trading slightly above 37 cents to the dollar, near a record low.
Up until Dec 3 last year they had been trading at 100 cents on the dollar, whilst in August the company reported a 34 percent rise in its net profit for first half of the year, suggesting all was well at the firm.
Kaisa officials did not respond to request for comment.
Their troubles have put a stop to the boom in bond issuance by Chinese property companies.
Traditionally January is a very busy month for high-yield issuers to raise funds either in the dollar bond or dim sum markets.
However, bankers and investors say they have yet to see any high-yield issuance from Chinese property companies so far and the next few weeks will remain tough for these issuers as investors are likely to demand a higher premium to buy their paper.
“We sold all our Kaisa dim sum bonds at the beginning of December and we are concerned about property names in the short term, especially those from Guangdong,” said an Asia-focused fixed income fund manager in Hong Kong, referring to the province in southern China where Shenzhen is located.
Funding costs for property companies in the dim sum and dollar markets have began to jump since Kaisa’s problems began, with traders saying there are few property bonds in the market that trade with a yield below 10 percent.
“A lot of issuers stopped issuing bonds because of the Kaisa event,” said Paul Au, Asia head of debt syndication at UBS in Hong Kong.
“The next few weeks will remain tough”.