Markets must not forget Kaisa lessons too quickly
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Markets must not forget Kaisa lessons too quickly

China Property (resized 230)

Kaisa Group Holdings became the first Chinese property company to default on its offshore debt when it announced on Monday that it had failed to pay $51.6m of coupons on two of its outstanding dollar bonds. The news barely made an impact on secondary prices, as the default had been well flagged, but markets should not relax yet. Kaisa may not be an isolated case.

The number of offshore bond defaults by Chinese companies can be counted on one hand. Asia Aluminum Holdings, Titan Petrochemicals and LDK Solar are among the very few to have undergone debt restructurings.

That’s why looming fears of Kaisa’s first offshore default and the possible effects on the Chinese real estate sector — which accounts for more than 40% of Asia’s high yield market — forced other Asian issuers onto the sidelines earlier this year, as investors digested the news.

The company has been under financial pressure because of the fallout from the Chinese government’s crackdown on graft. In the wake of an alleged corruption scandal involving a former security chief of Shenzhen, where the company is based, local authorities suspended Kaisa’s property sales and new projects in the city late last year.  

This precipitated the company’s financial troubles, including its default on a HK$400m ($51.6m) loan and missing the coupon payment of its $500m 10.25% 2020 bond in January — although it made that payment within a grace period.

Despite beginning an offshore debt restructuring programme last month, the real estate company finally waved the white flag on April 20, defaulting on two offshore bonds — its $250m 12.875% 2017s and its $800m 8.875% 2018s. It failed to make payments of $16.1m and $35.5m within a 30 day grace period.

Even before the deadline passed, the market was braced for the default. On March 24, Standard & Poor’s had said it expected the company to miss the payment due to its stressed liquidity, downgrading it from SD to D.

So it was not surprising that the secondary market failed to a register a reaction to the default on Tuesday. Kaisa’s 2017s and 2018s notes remained relatively flat, at a bid/offer of 55/59, with also little movement in other areas of Asia’s high yield market.

Political risk

While in one sense it is good news that the market has come to terms with the first offshore default and is differentiating between different Chinese property credits, it’s important to remember that many of Kaisa’s problems are related to political rather than credit risk.

This is not an isolated case of one troubled real estate developer. Political risks surround Chinese property issuers as the central government’s clampdown on bribery and corruption goes on. As the probe goes in full swing, the market can’t rule out the possibility that other developers could become embroiled.

There is hardly any country that is free from regulatory and political risk, but in single party states like China, where public officials are entrenched in its fast economic development, those risks are high. This is especially so given that China’s real estate sector has been one of the main pillars of the country's economic development over the last decade.

And the Kaisa saga is far from over. The restructuring programme, in which the company requested that the maturities of its five outstanding offshore bonds and one convertible bond be extended by five years, along with a big reduction in coupons, has not been universally welcomed.

Even though offshore creditors would receive similar treatment to their onshore counterparts despite the structural subordination of the notes they hold, some investors were disappointed by the longer than expected maturity extension proposed.

This has resulted in a group of offshore bondholders rejecting the initial proposal. There is a stalemate while investors wait to see if a new plan is put forward.

Kaisa’s case has been a good litmus test for Asia's debt capital markets — and for investors' ability to cope with defaults in a market that rarely has to deal with the problem of missed payments. But with political risk rising in China at a time of slowing GDP growth, the market would be wise to not to forget the lessons of the past.