Still wary of China property bonds

In spite of signs of investor demand, default worries continue to stalk China's high-yield property sector, FinanceAsia's 5th Borrowers and Investors conference heard.

Foreign investors by and large remain bearish towards Chinese high-yield property company bonds, despite a recent pickup in activity in the sector, a leading industry conference heard on Thursday. 

At FinanceAsia's 5th Borrowers and Investors conference in Singapore, speakers drew attention to the double whammy of rising debt and falling profits that is hitting some of the country’s property developers and dragging on credit quality.

“Like the companies in overcapacity industries, many of the Chinese property developers face compressing gross profit margins and growing leverage, which is not good for the outlook of the high-yield bonds,” Clement Chong, senior credit analyst at NN Investment Partners, told delegates.

“Given the increasingly stretched valuations, we have trimmed down some of our holdings in high-yield Chinese property debt,” said the Singapore-based fund manager, who specialises in real estate, gaming, and utility companies.

Some Chinese property bond yields trade at a similar level to their US counterparts but investors in US dollar debt of Chinese house builders generally receive less protection in the event of bankruptcy, a risk that some investors have been taking too lightly, the conference was told.

Yields spreads on Chinese property company bonds are trading close to the levels of their similarly rated US peers, so why should investors buy Chinese bonds given the extra subordination risk and default risk, said Todd Schubert, head of fixed income research at Bank of Singapore. 

“From a valuation point of view, [the] Asian high-yield market has more problems,” he said. 

Chinese property developers have been issuing offshore US dollar-denominated bonds and syndicated banks loans since 2012, raising almost $68 billion in total, according to data provider Dealogic. In the main, they have issued this debt through Cayman Islands- or British Virgin Islands-registered entities, leaving offshore investors at the end of the queue in the event of a corporate default or failed payment.

Shenzhen-based Kaisa Holdings, one of the first Chinese property developers to miss payments on its offshore dollar bonds in 2014, has been undergoing a prolonged debt restructuring process. In an April 20 filing with the Hong Kong Stock Exchange, the company said it is seeking to use US bankruptcy law to help its restructuring in the High Court of Hong Kong.

The stretched valuations of some Chinese property bonds is partly due to the relative lack of new supply. Only four property developers have raised dollar-denominated debt this year; the bulk of them have tended to raise debt finance by selling bonds onshore.
China Aoyuan Property Group captured a sizable order book of $2.1 billion for its $250 million bond in April, suggesting demand for Chinese real estate credit risk remains as strong as ever.
In the wake of that transaction, after Aoyuan was able to price its three-year bonds aggressively, some debt capital market bankers said property developers were planning to return to international bond markets. But their optimism has since proved premature while the onshore market has remained active, with Hong Kong-listed Country Garden, incorporated in the Cayman Islands, raised Rmb$1 billion ($156 million) through the sale of a five-year panda bond.

The amount of capital raised in offshore dollar bonds by Chinese property developers amounts to just $3.2 billion so far this year, a 60% decline compared with the same period in 2015 and an 80% decline compared with 2014, Chong said.

The credit pressures nonetheless continue to build. The proportion of Chinese property companies with negative credit rating outlooks has hit a four-year high, with growth in property sales moderating in the next 12 months.

In addition, the inventory of unsold residential properties rose to a record 6.2 billion square metres last year, which would take at least five years to clear those empty houses, according to China Index Academy.

"Slowing sales growth and increasing competition among developers, particularly in higher-tier cities, means that profit margins will remain under pressure," Franco Leung, a credit analyst at Moody's wrote in a May 10 report.

This article has been amended to correct the percentage fall in the amount of capital raised in offshore dollar bonds by Chinese property developers so far this year, as cited by Clement Chong.

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