IN DEPTH: China's developers raise funds onshore

As policy is relaxed, more Chinese real estate firms are looking onshore for funding. Recent deals include bonds from Evergrande, Shimao Property and Yuzhou Properties.

For years there has been nothing but pervasive gloom hanging over China’s housing sector.

From Tianjin to Shenzhen, cities have been swamped with a glut of housing units no one wanted to buy, especially after the government imposed measures to cool the overheating market between 2005 and 2013.

China’s slowing economic growth has exacerbated the problem and heavily indebted developers still have two to five years of inventory to sell off particularly in tier-3 and tier-4 cities.

But now the sector is showing signs of renewed vigor. In the first eight months of this year, nationwide housing sales, measured by floor space, jumped 8%, against a 9% decline for the entire year of 2014, after the government cut interest rates five times since November and slashed down-payment requirements for homebuyers.

Developers who scraped by are driving a boom in domestic bond issues, encouraged by a slew of onshore market reforms by the government, the depreciation of the renminbi which makes repayment in dollars more expensive; significantly cheaper coupons onshore and the scope to issue deals in greater size. This comes as good news for developers, who have been looking at various options to raise funds as traditional mainland sources began drying up last year.

“A good number of real estate developers, particularly the private companies, are preparing to sell onshore corporate bonds,” said Jason Ho, co-head of debt capital markets at ICBC International in Hong Kong, told FinanceAsia  - a point echoed by credit ratings agency Standard & Poor’s, which expects the 53 rated Chinese developers to issue another Rmb100 billion ($15.7 billion) worth of domestic bonds in 2016 and about Rmb100 billion this year.

In its latest effort to raise funds onshore, Guangzhou-based Evergrande Real Estate said on October 15 it had raised Rmb20 billion through the sale of onshore bonds to private investors. Even though the coupon rates on the two tranches in this offering were higher than in its June and July deals, the cost to the company was still substantially cheaper than it would have incurred offshore.

Also selling bonds bonds in the same week ended October 16 were three Hong Kong-listed property companies that are fequent borrowers in the international bond market. Cifi Holdings, Shimao Property Holdings and Yuzhou Properties tapped China's previously closed $6.5 trillion bond market, raising a combined Rmb7.4 billion locally.

According to Dealogic, Chinese property developers have raised $45.8 billion in the first nine months of 2015, up 28% and 240% for the same period last year and 2013, respectively.

China Fortune Land Development said in September it plans to issue up to Rmb18 billion ($2.83 billion) of corporate bonds, the latest candidate to lay out an ambitious fundraising program in the onshore market.

For China’s government, maintaining the real estate sector’s health is crucial because property investment accounts for about 15% of GDP, almost quadruple its 4% share of GDP in 1997, according to the IMF.

So the Chinese Securities Regulatory Commission opened the gates for non-mainland listed real-estate companies to raise corporate debt locally in January, allowing them to lower their funding costs at a time when offshore debt markets have become more expensive and less dependable. Overseas investors were spooked by the bond default at Hong Kong-listed Kaisa Group Holdings and turned more cautious on any high-yield G3 offerings out of China.

According to Dealogic, high-yield bonds issued by the homebuilders offshore have dropped from their peak levels in 2014. They only raised $6.3 billion across 17 high-yield bonds in the first nine months of 2015, almost half the amount they raised in the past two years when they sold $11.5 billion in 2014 and $12.8 billion for 2013, respectively. The high-yield credits sold by Chinese property firms represent more than 45% of the overall high-yield issuance for Asia ex-Japan region in the past two years.

On top of overseas investors’ lukewarm appetite for Chinese bonds, developers are also reluctant to sell more offshore US dollar-denominated bonds due to the shock renminbi deprecation of August 11 – the biggest one-day change since 1993 - and the subsequent two days as they need to mitigate the exposure to the greenback.

According to HSBC, the largest G3 bond underwriter in Asia ex-Japan region in 2015, China’s property and infrastructure sectors stand out as the most exposed to foreign exchange markets due to high US-dollar debt. It flagged China Overseas Land and Investment (COLI) and SOHO China as the two Chinese companies with the highest percentage of offshore debt at 82% and 72%, respectively.

Besides the currency risk from making regular bond payments and paying off US dollar debt if the renminbi continues to devalue, Chinese property developers pay an average coupon rate of 5% for onshore issues versus a coupon rate of 7.5% that they pay in the offshore market, according to Standard & Poor’s.

In some cases, the gap can be a lot wider. So it’s a no-brainer for Chinese property companies like Guangzhou-based Evergrande Real Estate, which has already gone down the onshore route and reaped record-low funding costs in the company’s history.

“Evergrande’s Rmb20 billion of bond issuance is a significant event for the onshore bond market and property developers, supported by favourable credit ratings and demand from Chinese investors,” said Howard Lam, a Hong Kong-based partner at global law firm Latham & Watkins.

Having sold a Rmb5 billion bond via a wholly owned subsidiary in June, Evergrande, the country’s second-largest property firm by sales, sold Rmb6.8 billion of four-year unguaranteed notes yielding 5.3% and another Rmb8.2 billion issue of seven-year bonds yielding 6.98% in July.

These are the lowest coupon rates that it has ever paid on bonds, the company said at the time. They also contrast sharply with the 12% coupon Evergrande paid on a downsized $1 billion five-year bond that it sold offshore in February.

In an effort to assuage investors’ nagging worries over its high debt levels racked up in the past few years, Evergrande chairman Hu Ka-yan said in August that sales were still expected to grow at a 30% annual clip over the next few years despite a slowing housing demand.

Hu said the company would speed up turnover and refinance debt by tapping cheap funding onshore to replace some of its previously incurred debts.

The coupon rates on Evergrande’s perpetual bonds are lucrative for investors. The return is about 10 to 11% for the first two years, and increases to 12 to 13% for the third year and 16 to 18% for the fourth year and onwards. The escalated coupon rates forces Evergrande to refinance and buyback the instruments without a maturity date by issuing cheaper onshore bonds.

Its outstanding perpetual bonds stood at a relatively alarming level of Rmb52.4 billion in June. Analysts continue to urge the company to speed up its deleveraging process.

Evergrande plans to use the proceeds from its latest onshore bonds to pay down some of its $10 billion-worth of perpetual bonds after the company paid 22% of its first-half profit, or 48% of core net profit, to service them.

Avoiding a hard landing
Beijing is working hard to avoid an economic hard landing after slowing growth led by weakness in exports and investment. a key part of this is loosening its grip on the housing sector, egged on by evidence that shows speculative demand is waning and record-high house prices in late 2013, when they are leveling off or even falling in secondary and tertiary Chinese cities.

Investment in residential property China has been high compared with other countries. It accounts for 15% of both fixed asset investment and total urban employment, according to the International Monetary Fund.

A Chinese economic hard landing would have a significant impact on global growth and economic stability, with economies in Asia and major emerging market commodities exporters among the hardest hit, Fitch said in an October 1 report.

In another move to stimulate housing demand, the People’s Bank of China cut the down payment for first time home buyers to 25% from 30% on September 30, in a move to help speed up the destocking process.

This latest move would not apply to the four tier-one cities – Beijing, Shanghai, Guangzhou and Shenzhen – or Sanya in Hainan province, where home purchase restrictions would remain in place. 
In August, the minimum down payment on residential properties ratio was cut to 20% from 30% for second-homebuyers that have already paid off the mortgage on their first homes. Foreign individuals working or studying in China are also no longer limited to buying just one residential property in some cities.

At the same time, the CSRC in January gave those real-estate developers not listed in Shanghai and Shenzhen the green light to raise debt through public offerings, allowing companies like Evergrande to tap the domestic bond market for the first time.

Among the developers poised to follow Evergrande is Modern Land, a firm which specialises in building energy-efficient homes and which expects to borrow up to as much Rmb1 billion this year through an approved quota of Rmb1.2 billion, representing a very high 40% of net asset value of one of its onshore subsidiaries.

“Issuing bonds in China’s onshore market makes a lot of sense to property developers because of the big gap between interest rates in China and the offshore US dollar market,” Wang Qiang, chief financial officer of Modern Land (China), a Hong Kong-listed mainland property firm, told FinanceAsia.

Different strokes
In the offshore dollar market, high-yield issuers with weaker debt profiles often pay more than 10% to 13%, while investment-grade borrowers – often referred to as blue-chip companies - like China Overseas Land or China Resources Land can borrow at a relatively advantageous coupon rate of 5%.

“The main reason [developers issue onshore bonds] is down to the [low interest] rates,” Christopher Yip, a senior director for corporate ratings at Standard & Poor’s, told FinanceAsia. “But as the credit differentiation onshore is much narrower … Evergrande pays less than half of what it does offshore. That’s a huge benefit [for it].”

“Those lower down in the credit ratings [offshore] and those with weaker financials will benefit the most [from the onshore bond market],” Yip said.

For instance Evergrande – rated B2/B/B by the three global ratings agencies for its 2020 dollar bond – was rated triple-A by domestic agency Dagong Global for its yuan bond of the same tenor.

There are many cases in which Chinese and international credit rating agencies disagree on ratings. One of the most controversial examples is that S&P rates Evergrande as B+ which is below investment grade, yet three domestic Chinese agencies give it an AAA rating -- the highest credit-rating level.

“Offshore bondholders are subordinated to onshore creditors with no access to domestic cash flows or onshore assets. This also explains why many offshore bonds offer high yields to attract investors,” Sharon Law, director at Cbre Capital Advisors, told FinanceAsia.

In addition to a different credit rating system in domestic market, bankers said the changing regulatory landscape in China means deals can also be completed faster and in greater size.

“For the moment the Chinese government is supportive to the onshore funding market, which is advantageous for many developers’ fundraising needs as they can have access to cost-competitive capital at a much faster timeframe than before and in some cases [on a] bigger scale than what is available for them in the US dollar bond market now,” William Fung, a debt syndicate banker at UBS in Hong Kong, told FinanceAsia.

Onshore deals right now can be valued anywhere up to Rmb10 billion ($1.6 billion) compared with average offshore deals of between $100 million to $1 billion, according to UBS.

Being a household name in China, Evergrande easily exceeded the range to raise a combined Rmb20 billion in July and June, underscoring an ample liquidity in the onshore market over the offshore market.

Push factors
The booming domestic bond market comes against a backdrop of tumbling equity markets, with the benchmark Shanghai Composite index losing more than 40% of its value since mid-June.

Companies have been forced to turn to bond markets as the equity markets are effectively closed to them.

Fantasia Holdings Group issued Rmb2 billion ($315 million) of domestic five-year bonds at a rate of 6.95% in September. In comparison, they issued $200 million of three-year offshore bonds in May 2015 at an 11.5% coupon.

Not only would borrowers be able to raise funds more cheaply via domestic bond markets they would also be able to mitigate the foreign exchange risks, according to an analysis by Sameer Sopori, BNP Paribas’s Asia Pacific head of debt capital markets origination.

“Offshore spreads in the G3 market have widened after Beijing’s decision on August 11 to depreciate [the renmimbi] and [amid] pessimism about [the] state of their economy, creating a more attractive channel to raise money onshore,” said Sopori.

Additional reporting by Julie Zhu

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