In Detail: Why Chinese Developers’ Offshore Bonds Are Collapsing
China’s credit crunch to the real estate sector and the China Evergrande group debt crisis have propelled the country’s riskiest bond yields to the highest level in a decade, making it difficult for Chinese developers to borrow. by selling offshore dollar bonds and threatening a wave of defaults.
This is not the first time that Chinese property developers’ offshore bonds have faced a massive selloff, but this time the headwinds are particularly strong as investors are not only worried about losses on bonds, but also started to question the overall credit of Chinese developers.
Many analysts say they don’t expect policy easing anytime soon. When the government can reverse its restrictive policy will depend on the extent of the sell-off of developer dollar bonds and its impact on the domestic bond market, said Lu Ting, chief economist for China at Nomura Holdings.
Yet officials including Vice Premier Liu He, Central Bank Governor Yi Gang and Zou Lan, head of the bank’s financial markets department, have ensured that the risks to the financial system stemming from Evergrande are controllable and are unlikely to spread.
Offshore bond sale
Evergrande – the world’s most indebted developer with more than $ 300 billion in liabilities – missed five earlier offshore bond payments in late September and early October, and an additional $ 573 million is due before the end of the year. This was followed by a surprise default by Fantasia Holdings and another missed payment by Sinic Holdings after a default warning.
Modern Land, a Beijing-based developer with $ 1.35 billion in dollar bonds outstanding, is asking holders for a three-month extension to repay a note due on October 25. The company’s $ 200 million bonds due February 2022 have plunged to less than 32 cents on the dollar recently from 93 cents at the end of September. Shenzhen-based developer Kaisa Group Holdings’ $ 550 million bonds, due April 2022, fell to 52 cents on the dollar, from 90 cents during the same period. Both companies had a B credit rating from Fitch Ratings.
Dollar bonds of at least a double-digit number from Chinese developers recently fell 20-30%. The yield on unwanted dollar bonds by the country’s borrowers, mostly developers, peaked at around 20% this month.
Amid the rapid cooling of housing sales across the industry, the market ignores the differences in operating performance between issuers and investors are shedding real estate company bonds because they cannot distinguish whether companies are already insolvent or simply have liquidity difficulties, according to an analyst at a major brokerage firm.
Fantasia’s flaw is fearful
A sharp drop in bond prices represents growing market expectations that more real estate companies are at risk of defaulting.
Fantasia’s default on $ 206 million in dollar bonds on October 4 surprised the market and stepped up the sale. Just two weeks before the default, the company said its operating conditions were good, had sufficient working capital, and had no liquidity issues.
Four days after the default, Fantasia founder and largest shareholder Zeng Baobao issued an internal letter to employees accusing S&P Global Ratings of a sudden and significant downgrade for the company’s tight liquidity. The company also said a change in the Shenzhen local government’s requirements on its bank account caused a delay in sales of its city renewal project, affecting liquidity.
S&P downgraded Fantasia’s long-term credit rating from B to CCC on September 29. After the default, the three major credit rating companies downgraded Fantasia on default or near default.
Even though Fantasia is not a big developer in terms of sales, its failure has caused panic in the market. In the first nine months of this year, the company achieved sales of 40.87 billion yuan ($ 6.34 billion), ranking 64th in the industry. Its default has had a bigger impact on market confidence, and investors fear other developers facing redemption pressure – but still looking for solutions – will follow suit, a hedge fund person said. Hong Kong.
Slow house sales
Many developers scramble to avoid or delay default by speeding up sales, extending debt, making buybacks, or borrowing from major shareholders.
Since the implementation of the government’s “three red lines” policy in August 2020, generating funds through the sale of housing has become a priority for developers. The policy limits the ability of promoters to borrow based on their liability / asset ratio, net debt / equity ratio and cash / short-term debt ratio. But the slowdown in home sales has made this approach difficult.
New home prices in 70 cities, excluding state-subsidized housing, fell 0.08% in September from August, the first drop since April 2015, figures from the National Bureau of Statistics showed on October 20. . Secondary market values fell 0.19%, down for a second month.
Normally, developers sell homes to consumers before projects are completed. Once homes are sold, developers cannot access the funds until the buyers’ mortgages have been approved. At the start of the year, banks typically took around 50 days to approve mortgages. Now the loan cycle can take two to three months or more, Caixin learned.
Even after developers receive funds from sales, they can only use part of the money. Presale funds, including down payments and mortgages, must be deposited into a designated account regulated by the relevant departments and financial institutions. Prior to the completion of projects, some of these funds can only be used to pay for construction costs and taxes and cannot be used for other purposes such as debt repayment.
Local governments typically require 10-15% of funds to be kept in special accounts. Lenders also require that a certain proportion of funds be kept in the accounts in the event of non-performing loans from promoters. Today, many cities across the country are stepping up monitoring of these accounts. The oversight and requirements in each city are different, but it’s estimated that developers can only use 30-50% of account funds, an executive at one of the top 20 developers told Caixin.
Companies used to choose offshore refinancing to pay off maturing debt. They usually plan six months or even seven or eight months in advance to issue new offshore bonds. But the turmoil in the bond market has made it difficult for Chinese developers to borrow abroad. Even A-rated issuers have difficulty selling new dollar bonds, an official at a Hong Kong-listed Chinese developer said.
Sales of international bonds by Chinese developers practically froze amid the Evergrande crisis. Since June, only one developer has managed to sell a bond this month, worth $ 102 million. In the first three quarters of 2021, Chinese developers issued $ 40 bonds worth $ 9.1 billion, down 31 percent from the same period last year, according to data from Dealogic.
A total of $ 59 billion in offshore bonds by Chinese developers will mature in 2021, and $ 61.5 billion are due in 2022, according to data from bond news site 97caijing.com. January, March, April and June 2022 will be the peak months for debt repayment.
Chinese promoters’ dollar bonds were once the darlings of investors because they offered high yields and had a relatively low default rate. Before 2021, only three developers had defaulted on an offshore bond: Kaisa Group in 2014, Mingfa Group International in 2018 and Tahoe Group in 2019, a senior Hong Kong bond investor said.
Even in the midst of a growing risk of default, there are always investors looking for good deals. Some investors buy Evergrande’s dollar bonds cheaply because they believe the company’s assets will be valuable regardless of how they are restructured, an offshore Evergrande creditor has said.
These are usually asset managers who invest in specific bonds rated for poor quality or in difficulty, but all buy-side institutions must now consider whether they will really have a say in the restructuring of payments.
According to Bloomberg, investors in Evergrande’s dollar bonds include large international institutions, from asset management companies to government investment funds. Six of the seven largest Asian high-yield bond funds have shied away from Evergrande dollar bonds since May, reducing their holdings to less than 1% of their portfolios in August, from 3%, according to Morningstar.
But because Evergrande and other Chinese developers are included in international high yield bond indices, funds that track the indices cannot sell their holdings as freely.
For the creditors of Chinese developers, short-term financial difficulties are inevitable. But in the long run, foreign investors can still participate in China’s high-yield, diversified bond market with the right research methods and selective deployment, said PineBridge Investments, a global private asset manager.
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