China’s property companies are used to rapidly constructing assets. In the past year, they’ve taken those skills into the financial realm.
Increasing numbers of real estate firms have looked to replace expensive international debt with cheaper onshore funding, after finally being given access to China’s onshore bond market in January.
According to data-tracking firm Dealogic, China’s property developers have already raised $60 billion via domestic bonds this year. They look likely to raise another $56 billion in local debt in 2016, according to Citi.
Their desire to raise onshore funds makes sense. The developers often have to pay coupons of around 8% to 12% on international dollar bonds. Meanwhile, China has been cutting interest rates. On October 22 the People’s Bank of China conducted its sixth cut in a year, and it freed up banks to lend more money for a fourth time over the same period.
The result is that the real estate companies can often issue local bonds with a coupon rate of 7% or less.
“It makes sense for the property issuers to take advantage of falling interest rates in China to repay their offshore debt early and tap the onshore debt market,” said Sharon Law, a Hong Kong-based director at CBRE Capital Advisors.
The companies have had little difficulty finding onshore funding. Evergrande Real Estate, China’s second-largest property firm by sales, raised a record Rmb40 billion ($6.22 billion) from three bond sales this year.
But the next step could prove trickier: convincing international investors to surrender the bonds they bought in exchange for cash.
“It is all about how much premium the issuer is willing to pay in order to buy back their existing bonds,” Tony Chen, a Hong Kong-based credit analyst at Nomura, told FinanceAsia. “There is a divergence of views among investors and issuers about exactly how much the premium should be because there is no standard way to measure it.”
He added: “In many cases the premium could be one or two points above its cash price in the secondary price.”
There is a lot for them to do. Moody’s estimated the property companies’ outstanding offshore debt to be $62 billion in October, including US dollar-denominated bonds and offshore renminbi, or so-called dim sum, bonds.
Their ability to claw back all of this debt cannot be taken for granted. As some of China’s property companies are beginning to discover, what is good for them is not necessarily seen in the same light by the offshore investors holding their bonds.
The desire of China’s property companies to exchange offshore bonds for onshore makes complete financial sense – for them.
The companies are operating in a soft market, in which oversupply and a weakening economy have left house prices flat. That in turn has impacted their health, which is a concern for Beijing. Homebuilders and related industries from cement production to steel making represent about a quarter of economic output, according to the China’s National Bureau of Statistics.
By cutting down their debt servicing costs, the property developers can give themselves some extra balance sheet room. Additionally, international dollar debt typically carries sterner covenants about areas such as debt management, and the acquisition or sale of assets. By removing the bonds, the companies give themselves greater operating freedom.
“In the past 12-24 months, liability management as a technique has grown in popularity among both issuers and investors,” said Hemant Lodha, head of ratings advisory and liability management for Asia Pacific at HSBC. “As a refinancing mechanism, it enables issuers to exert greater flexibility over their existing liabilities, as well as remove or amend existing covenants that are no longer suitable for the company’s business profile.”
Chinese property developers have a number of options to reconfigure their borrowings.
They can purchase their existing bonds through a tender offer, offering cash for the outstanding debt, or they can try to swap their existing debt with new bonds, usually issued at a lower coupon or at longer maturities, though an exchange offer.
“Through either an exchange or tender offer, Asian companies will seek to manage their balance sheets more efficiently as they can tap the abundant liquidity in China’s domestic market,” Alexander Lloyd, a partner at law firm Clifford Chance, told FinanceAsia.
He expects to see many tender offers in the next year as property companies try to replace their offshore debt with onshore alternatives. Future Land Development and China Aoyuan Property are among the companies mulling a tender offer for their outstanding bonds.
Another option for property companies is to seek to amend the terms of their outstanding offshore bonds to avoid potential covenant breaches, or to include a call option that enables issuers to redeem bonds before they mature. Developers can then increase their dividend payout, or gearing levels.
“In most cases Asian issuers, mostly the Chinese property developers, will seek to increase their financial flexibility by amending the terms [of their outstanding debt],” William Fung, a debt syndicate banker at UBS in Hong Kong, said.
The exchange process appears to have started. In a December 2 stock exchange filing, Country Garden, a Hong Kong-listed mainland property firm, said it intended to amend the covenants on four of its existing dollar bonds, to give it greater financial flexibility to expand into businesses outside of homebuilding.
However, liability-management exercises can sometimes prove controversial.
In September Soho China, a Beijing-headquartered developer, said it intended to buy back its 7.125% 2022 bonds in a cash tender offer after it sold its share of a joint-venture project with Fosun International. After getting a lukewarm response from its bond investors, Soho China intends to issue up to Rmb3 billion worth of bonds domestically, likely at a coupon rate of 5%-7%, instead.
But its proposal to buy back the $400 million-worth bonds was not well received by investors, partly because their price rallied in the secondary market following news of the sale. Soho China ended up buying back less than half the outstanding bonds.
Other Chinese property developers are likely to follow. In early December, Yuzhou Properties told the Hong Kong stock exchange that it plans to raise up to Rmb3 billion of bonds domestically, while hotels group China Jin Mao told the bourse it wants to sell up to Rmb2.2 billion on the mainland. Both companies have outstanding dollar bonds, and they will likely seek to replace them with these cheaper local bonds.
Less clear is just how willing international investors will be to surrender their high yielding assets. As Nomura’s Chen noted, “the buyback process is often a mutual agreement between the largest investors and the issuer itself.”
Many of the high-yield offshore bonds are dominated by a handful of large investors. The companies typically approach them first, hoping to get their acquiesence for the buyback before moving on to smaller holders of the debt.
But Soho China’s experiences shows offshore investors are not necessarily willing to play ball.
The situation is made more complex by the fact that high-yield bond issuance has collapsed in Asia – mostly because the property companies are no longer borrowing internationally. As a result, investors have few alternative new deals to put their money into. So they are reluctant to give up high-yielding investments from reputable borrowers.
“The low [investor] acceptance rate of Soho China’s bond reflects preference [among international investors] for reliable names,” a Hong Kong-based fund manager with a European investment firm told FinanceAsia. “For high-yield investors the level of compensation has been embedded in the coupon rates they receive, offering little incentive to sell their bonds back to the issuer.”
Some of the outstanding bonds feature calls, and the companies may be content to wait until they can exercise them. Chen estimates there to be $8 billion of outstanding bonds that will become callable in 2016. A lot, if not all of these, are likely to be called back. But that still leaves a lot of bonds that lack timely call options. The companies that issued them will likely want to negotiate a solicitation.
They may find that they need to offer generous terms (above par) to get offshore investor agreement. Fund managers face declining return outlooks across global asset classes, and will demand a high price to give up one of the few high-yielding securities still available.
The ability of China’s property companies to negotiate buybacks will determine just how much they can truly save – and how willing they are to jeopardise relations with the global investors that supported them in a time of need.