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Thursday, December 2, 2021

The bond crash has exacerbated the “downward spiral” risk for China’s real estate groups

This week, junk bonds issued by riskier Chinese real estate developers were sold off, causing their borrowing costs to soar to their highest level in a decade and jeopardizing companies’ ability to obtain important sources of funding.

As the US dollar-denominated bond market for speculative credit-rated Chinese companies is in turmoil, people are increasingly worried about the failure of large real estate developers such as Evergrande, Sony and Fantasia to pay for a series of bonds.

The industry is struggling to cope with the slowdown in China’s real estate market and pressure from Beijing to reduce debt, and as companies desperately need cash to avoid defaulting on debt, the industry is now facing excessive borrowing costs.

“The downward spiral of Chinese developers is the result of a massive liquidity tightening,” said Paul Lukaszewski, head of corporate debt for the Asia-Pacific region at Abrdn. “Very few companies can survive long-term in an environment where internal cash or external financing is not available.”

Kaisa is one of the largest borrowers in the industry, and this week may add a growing list of companies that missed interest payments before the two imminent deadlines facing their offshore bonds. Earlier this week, it pleaded with investors for “more time” after failing to pay for wealth management products in mainland China.

Its trajectory echoes the trajectory of Evergrande, the world’s most indebted real estate developer. After several weeks of problems with its guaranteed wealth management products, Evergrande missed offshore bond payments in September, initially reminding the global market to pay attention to Chinese real estate Industry issues. Holders of some Evergrande bonds stated that they had received payments before the 30-day grace period expired on Wednesday.

Since September, the international bond market has basically been closed to real estate developers. The average yield of the Ice Data Services Index of China’s high-yield US dollar bonds, dominated by real estate companies, jumped from 14% in early September to nearly 29% this week. This increase brought the key barometer of borrowing costs to the highest level since the 2008-09 global financial crisis.

Investors compared this week’s real estate bond drama with the scenes of that period and the 1997-98 Asian financial crisis, but they pointed out that industry-specific problems have not yet spread to other capital markets or industries in the region. On Wednesday, China was able to issue euro-denominated sovereign bonds in several installments, with the three-year portion priced at negative yields. According to data from Ice Data Services, the average yield on investment-grade bonds in China is only 3%.

Ice BofA Asian dollar high-yield corporate China issuer index line chart shows that China's junk bond yield has risen to the highest level since the global financial crisis

Because of the role of Chinese real estate developers in building houses in a rapidly urbanizing economy, they have become the most prominent borrowers in the entire US$400 billion high-yield bond market in Asia. But since concerns about asset bubbles in the real estate market intensified last year, they have faced pressure from Beijing to reduce their huge debts.

The liquidity problem that initially attacked the debt-laden Evergrande in the summer has swept across several peers, who defaulted on offshore debt last month. Chinese real estate developers rely on a steady stream of real estate sales to bring in cash, but the mainland market has slowed down significantly in recent months, and housing prices have been under pressure.

Larry Hu, chief China economist at Macquarie, said: “I think there may be more defaults in the future and spread to other developers.” “I don’t think they can issue bonds anywhere now.”

According to Dealogic’s data, as of the fourth quarter, China Real Estate Group has raised US$320 million through the issuance of only two US dollar bonds. During this period, they usually raised billions of US dollars.

As a sign of growing vigilance over the severity of the offshore market sell-off, officially supported media this week said that some of the recent restrictions on the industry may be relaxed.

“Securities Times” reported on Wednesday that some developers may enter the inter-bank market to raise funds. Some companies with higher ratings have yields that are inversely proportional to prices.

The 2024 maturity bonds issued by Country Garden, China’s largest developer by sales, rose 5 cents to 91 cents on Thursday after falling earlier this week, but investors pointed out that lower-quality companies have not recovered from the gains. Benefit from it.

In addition to restrictions on developer debt, China also imposed restrictions on mortgage loans earlier this year as part of its efforts to control asset prices.

Data released by the People’s Bank of China on social media accounts on Wednesday showed that mortgage loans increased in October from the previous month. Analysts said that this may mean that the central bank wants to appease investors who are worried about China’s real estate market.

“The marginal relaxation of mortgage loans is not enough to prevent further deterioration of the pressure on capital-strapped developers,” said He Wei, an analyst at Longzhou Economics in Beijing.

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