China property facing key Kaisa test

Kaisa's loan default is a crucial test for offshore investors and lenders. Should Kaisa flunk it, access to funding could be shut off for many property firms.

With a bond interest payment looming, all eyes are on Kaisa after it defaulted on a bilateral bank loan, triggering broader concerns for the Chinese property sector and its ability to continue accessing offshore funding markets.

The default by Kaisa this month on a HK$400 million ($51 million) loan with HSBC could yet trigger a cross-default on about $2.5 billion worth of its offshore bonds, potentially marking a first for China's sizeable and troubled real estate sector.

Crucially, Kaisa is due to make an interest payment of about $26 million on Thursday on its $500 million 10.25% notes due in 2020.

Standard & Poor's on January 5 said there was a high likelihood that the company will default on its upcoming obligations given that Kaisa could not meet the repayment of the relatively small loan extended by HSBC.

Kaisa's problems are a worry for Chinese real estate as a whole. Offshore investors have been buying Chinese property debt in droves and willing to accept unsecured bond structures, where they are deeply subordinated to onshore lenders, who would have first dibs on any assets in the event of a default.

"This will test the offshore holdco bond structure," said Hong Kong-based Howard Lam, a partner at global law firm Latham & Watkins. "A lot of investors have been buying into such structures and real estate makes up the bulk of the [China] bond issues offshore, so this is a test case for an important sector."

There is certainly plenty at stake. According to data provider Dealogic, there is a total of $55.7 billion worth of outstanding G3 bonds from the Chinese real estate sector. Some $6.6 billion of it matures this year.

"The Hong Kong-listed Chinese property developers have mostly depended on offshore funding to finance their land acquisitions," Fitch analyst Ying Wang told FinanceAsia. "[But] the risk appetite for the real estate sector is likely to be dampened if offshore creditors end up taking big losses in Kaisa's case, which will make it difficult for weak high-yield property developers [to] refinance maturing bonds and loans or obtain fresh financing.” 

As such, the market will be watching closely to see how Kaisa's debt woes are resolved. "It will be interesting to see how the Chinese government is going to resolve the case, where you have onshore bank lenders, trust lenders, the home buyers as well as offshore lenders and bondholders," Fitch's Wang added.

Kaisa bonds plunge

Kaisa's loan default was triggered by the resignation of its erstwhile chairman Kwok Ying Shing. That, together with a few other executive resignations and the termination of some partner agreements, sent rumours swirling around that the company was being wound up.

However, in an exchange filing on Wednesday Kaisa said that it had not passed any resolution to wind up or restructure the group and that it is assessing the impact of its loan default on its broader financial position.

According to one banker, banks are pitching for a role advising Kaisa on any debt restructuring.

Kaisa's stock remains suspended but its bonds continue to trade and they have been plummeting. Kaisa's 2019 and 2020 bonds, which were trading at par over a month ago, sank to 33 and 34 on Wednesday, according to Bloomberg data.

In a note, credit research firm Lucror also cited weakness elsewhere, with the yield on the JACI high-yield corporate index jumping 32 basis points on Tuesday and Chinese property bonds slipping by three to six points.

"Because of this event the secondary market has been volatile for the last week or so," Paul Au, head of head of debt syndicate Asia at UBS, said at a media briefing on Wednesday. "A lot of these companies are now waiting, like all of us, trying to find out what is going to happen on [at] Kaisa...The next few weeks will be tough for issuance."

Among the Chinese real estate developers waiting to to tap bond markets are Guangdong-focused Agile Property, which completed investor meetings on January 5, and Shanghai-based CIFI, which was planning to add on to its existing $200 million 2019 bonds.

Limited and discouraging precedents

Two Chinese property developers -- Greentown and Renhe Commercial -- have previously gone through distressed debt exchanges but there are no clear precedents on what a Chinese property bankruptcy process and recovery outcome might be like.

"We don't really have a lot of precedents in this scale in terms an offshore default," said Chris Yip, an analyst at S&P. "There hasn't been a thorough workout so Kaisa will serve as a case study for both for offshore and onshore obligations."

Outside property there are a few precedents of offshore debt restructuring, which are not encouraging. When Asia Aluminium defaulted on its offshore bonds in 2009, there were low levels of recovery below 20 cents to the dollar. Other examples include Titan Petrochemicals, Sino Forest and LDK Solar.

Chinese law surrounding bankruptcy has also been opaque, not exactly lending confidence to investors. "At this point there is not a lot of consistency and transparency in the way the Chinese courts handle bankruptcy so you never know," said Fitch's Ying.

"For Asia Aluminium, offshore creditors got very little in a default scenario," she said.

Latham & Watkins' Lam suggests that the recovery levels for property firms such as Kaisa could be better. "For property companies, the assets are more tangible so [one would hope that] there could be higher recovery compared to other sectors in which assets could disappear more easily," he said.

Which would still be cold comfort for investors and lenders.

(Additional reporting by Chien Mi Wong and Alison Tudor Ackroyd)

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