China's tightening of credit to the real estate sector and the debt crisis at China Evergrande Group have sent yields on the country's riskier notes to the highest level in a decade, making it hard for Chinese developers to borrow by selling offshore dollar bonds and threatening a wave of defaults.
This is not the first time Chinese property developers' offshore bonds faced a sell-off, but this time the headwinds are particularly strong, as investors are not only worried about losses on the bonds but also have started to question Chinese developers' overall credit.
Many analysts say they do not expect a policy-easing soon. When the government might reverse its restrictive policy will depend on the scope of the sell-off of developers' dollar bonds and how much it affects the domestic bond market, said Lu Ting, chief China economist at Nomura Holdings.
Still, officials including Vice Premier Liu He, central bank Gov. Yi Gang, and Zou Lan, head of the bank's financial market department, have made assurances that risks to the financial system stemming from Evergrande are controllable and are unlikely to spread.
Offshore bond sell-off
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 has a further $573 million coming due before the end of the year. That was followed by a surprise default by Fantasia Holdings and another missed payment by Sinic Holdings after a default warning.
Modern Land, a Beijing-headquartered developer with $1.35 billion in dollar bonds outstanding, is asking holders for a three-month extension to pay off a note due Oct. 25. The company's $200 million of dollar bonds due February 2022 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 of dollar bonds due April 2022 declined 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 of Chinese developers have plunged 20% to 30% recently. The yield on junk dollar bonds from the nation's borrowers, mostly developers, climbed to a decade-high of about 20% this month.
Amid the rapid cooling of housing sales throughout the industry, the market is ignoring operating performance differences among issuers, and investors are dumping property companies' bonds as they cannot distinguish whether companies are already insolvent or simply have liquidity difficulties, according to a fixed-income analyst at a large brokerage.
Fantasia's default raises fears
A sharp drop in bond prices represents increasing market expectations that more real estate companies are at risk of default.
The Fantasia default on $206 million of dollar bonds on Oct. 4 caught the market by surprise and caused the sell-off to intensify. Only two weeks before the default, the company said its operating condition was good, and it had sufficient working capital and no liquidity issues.
Four days after the default, Fantasia's founder and largest shareholder, Zeng Baobao, issued an internal letter to employees blaming a sudden significant downgrade by S&P Global Ratings for the company's tight liquidity. The company also said a change in the requirements by the local Shenzhen government on its banking account resulted in a delay in sales of its urban renovation project, affecting liquidity.
S&P cut the long-term credit rating of Fantasia from B to CCC on Sept. 29. After the default, all three major credit rating companies cut Fantasia's rating to default or near-default status.
Even though Fantasia is not a big developer in terms of sales, its default caused panic in the market. In the first nine months of this year, the company had sales of 40.87 billion yuan ($6.34 billion), ranking 64th in the industry. Its default had a larger impact on confidence in the market, and investors are worried that other developers are under redemption pressure -- but are still searching for solutions -- will follow suit, a person at a Hong Kong hedge fund said.
Slow home sales
Many developers are scrambling to avoid or delay a default by accelerating sales, extending their debts, making buybacks, or borrowing from major shareholders.
Since the implementation of the government's "three red lines" policy in August 2020, generating funds through home sales has become a priority for developers. The policy limits developers' ability to borrow based on their liabilities-to-assets ratio, net debt-to-equity ratio and cash-to-short-term debt ratio. But slowing home sales have made this approach difficult.
New-home prices in 70 cities, excluding state-subsidized housing, slid 0.08% in September from August, the first drop since April 2015, National Bureau of Statistics figures showed on Oct. 20. Values in the secondary market declined 0.19%, down for a second month.
Normally, developers sell homes to consumers before projects are completed. After the houses are sold, developers cannot access the funds until buyers' mortgage loans are approved. At the start of the year, it usually took about 50 days for banks to approve mortgage loans. Now the lending cycle can take two to three months or more, Caixin learned.
Even after developers receive funds from sales, they can only use a portion of the money. The presale funds, including down payments and mortgage loans, have to be deposited in a designated account regulated by relevant departments and financial institutions. Before the completion of the projects, some of these funds can be used only to pay construction costs and taxes and cannot be used for other purposes such as repaying debt.
Local governments usually require that 10% to 15% of the funds be retained in the special accounts. Lenders also require a certain proportion of the funds to be retained in the accounts in case of nonperforming loans by developers. Now many cities across the country are increasing supervision of such accounts. The supervision and requirements in each city are different, but it is estimated that developers can use only 30% to 50% of the funds in the accounts, an executive at a top-20 developer told Caixin.
Companies used to choose overseas refinancing to repay maturing debt. They usually plan half a year or even seven or eight months in advance to issue new offshore bonds. But turmoil in the bond market has made it hard for Chinese developers to borrow abroad. Even A-rated issuers face difficulties in selling new dollar bonds, said an executive at a Hong Kong-listed Chinese developer.
International bond sales by Chinese developers have all but frozen up amid the Evergrande crisis. Since June, only one developer managed to sell a bond this month, worth $102 million. In the first three quarters of 2021, Chinese developers issued 40 dollar bonds worth $9.1 billion, down 31% from the same period last year, according to data from Dealogic.
A total of $59 billion of offshore bonds by Chinese developers will come due in 2021, and $61.5 billion are due in 2022, according to data from bond information website 97caijing.com. January, March, April and June of 2022 will be the peak months for debt repayment.
Chinese developers' dollar bonds used to be investor darlings, as 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 amid rising default risk, there are still investors hunting for bargains. Some investors are buying Evergrande's dollar bonds at the low prices because they think the company's assets will have value no matter how they are restructured, an Evergrande offshore creditor said.
These tend to be asset managers that invest in specific junk-rated bonds or distressed bonds, but all of the buy-side institutions now need to consider whether they will really have a say in restructuring payouts.
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 been offloading Evergrande's dollar bonds since May, cutting holdings to less than 1% of their portfolios in August, down from as much as 3%, according to Morningstar.
But as Evergrande and other Chinese developers are included in international high-yield bond indexes, funds tracking the indexes cannot sell their holdings as freely.
For creditors of Chinese developers, short-term financial pain is inevitable. But in the long run, foreign investors can still participate in China's high-yield and diversified bond market with the right research methods and selective deployment, said PineBridge Investments, a private global asset manager.
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