China’s developers turn to home funding

China's bond market has gained favour this year with smaller, speculative-grade developers due to lower funding costs and market diversity.

China’s developers turn to home funding
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How would domestic issuance affect the developers' credit profiles?

This is a positive development overall. The impact is most pronounced on small or midsize developers that struggle with high funding costs and have more limited access to funding from banks and the offshore bond market.

These companies are likely to have used high-cost trust financing previously. The accessibility of domestic bonds will help ease their funding costs moderately. Although we don't expect developers' debt-servicing ability to improve considerably, the lower issuance costs could help provide them slightly more buffer against falling margins.

Bonds offer longer-term funding, which extends the developers' debt-maturity profiles and improves their liquidity positions. This is positive because refinancing risks and liquidity for many developers have deteriorated over the past year. Onshore bank loans are often short-term or tied to project completion schedules, leaving many developers with a large refinancing task each year. In our view, most Chinese developers have the ability to issue domestic bonds with maturities of up to five years--some even 10 years.

How would domestic issuance affect structural subordination of offshore bonds?

Domestic issuance will not have a substantial impact on structural subordination for offshore investors of rated developers. This is because we expect the proportion of onshore debt to remain largely unaffected. In addition, domestic issuances are unsecured, which means they will not create more asset claims. Structural subordination could improve if unsecured domestic bond funding replaces secured project loan funding at the project level.

Although both onshore and offshore bonds are unsecured and are theoretically equally ranked, differential treatment by the onshore legal framework may arise in the event of default. Investors offshore may also be left out of the negotiations happening onshore or be excluded from the borrowings assumed by an acquirer in a debt restructuring, as seen in the recent cases of Asia Aluminum Holdings Ltd. and FerroChina Ltd. Capital controls and legal enforceability could still place offshore investors at a disadvantage for recovery prospects.

In some cases, onshore creditors are favored in debt restructuring because issuers are more reliant on onshore creditors than offshore ones. For example, Kaisa Group Holdings Ltd. offered its onshore creditors substantially better terms than its offshore creditors. There is also a question as to whether a legal judgment by a foreign court for offshore bondholders would be enforced in China.

How would the reopening of onshore bond markets to developers affect offshore issuance?

We don't expect domestic bonds to substitute offshore issuance in the long term. About a dozen rated developers have issued a total of about Rmb70 billion of domestic bonds in the two onshore markets year-to-date. Together with rights issuance (when the equity window was momentarily accessible earlier this year), these funding actions have soaked up some of the financing needs from the offshore market for developers.

Although onshore issuance provides some diversification, the long-term availability of this funding tool depends on government policies. Onshore issuance is also currently subject to a longer and less-certain regulatory approval process, along with restrictions on issuance amount. In contrast, offshore bonds issuance has fewer such restrictions and is an efficient, well-established process widely accepted by investors.

Although the demand for refinancing of offshore notes in 2015 is relatively light, it will increase steadily over the next three years. We continue to expect Chinese developers to refinance maturing notes offshore given that these notes' individual issue sizes tend to be substantially larger than what domestic bond issuances have been able to achieve.

The author of this article is Hong Kong-based Senior Director of Corporate Ratings, Christopher Yip.


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