Chinese property: too big to fund?
Chinese property companies dominate Asia’s high yield bond market like never before. But rising volumes bring rising risks — and maturities are looming. Addison Gong reports
Asia’s bond market has a habit of defying expectations. At the start of 2018, bankers were expecting another bumper year of issuance, following a record-breaking 2017. Instead, they were forced to endure a volatile secondary market that made primary issuance difficult, and occasionally impossible. At the start of 2019, most bankers expected the tough times to continue.
They had every reason to. There was not yet a resolution to the trade disputes between the world’s two biggest economies. The US Federal Reserve was on track for more tightening. Brexit negotiations were at a standstill. China’s economic growth was finally taking a downward turn.
In the credit market, too, a sense of pessimism was brewing. Credit spreads had widened significantly throughout 2018. Chinese dollar bond issuers, who had been in the driving seat in recent years, looked like they were going to crash into a wall of maturing debt. Defaults were up onshore and there were widespread fears about contagion to the offshore market.
It did not take long for this pessimism to be forgotten. Issuers from Asia ex-Japan sold over $50bn of dollar bonds by February 22, according to Dealogic, representing an 18% yearly increase. Despite the heavy primary supply, the Markit iTraxx Asia ex-Japan IG index had tightened to 73bp by February 21, down from 95bp on January 1. The spread on Asia high yield bonds has tightened by some 250bp since the start of the year, according to analysts.
Chinese property developers, whose bonds were among the worst-hit by the 2018 volatility, have led the charge. Constraints on their use of proceeds from onshore bond issuance, as well as a crackdown on shadow banking, ensured these companies flocked to the market in 2018. They have only upped their issuance since then.
Chinese property companies had issued 2.75 times as many dollar bonds by February 22 as they had a year ago, contributing some $20bn to the total Asia ex-Japan dollar volumes, according to Dealogic. Most of these companies are rated high yield. Some have returned multiple times since the start of the year. China Aoyuan Group, Guangzhou R&F Properties and Yuzhou Properties have all tapped the market three times. Zhenro Properties has sold four deals in less than two months.
It is clear why issuers are making the most of the buoyant conditions in the dollar bond market, but why are investors so willing to embrace this deluge of issuance? One reason is that many of these companies are willing to pay up.
“We are by no means out of the woods yet but Asia has yield, and that has not gone unnoticed,” says Manu George, senior investment director, Asian fixed income, at Schroders in Singapore, who adds that he expects foreign interest in Asia to continue.
The market is also being helped, albeit indirectly, by the inclusion of Chinese onshore bonds in the Bloomberg Barclays global aggregate bond index in April. “The attractive yields of Asian high yield bonds, and expectations of inflows into the onshore China space will all contribute to investors looking at Asian bonds in a more positive fashion,” says George.
The $50bn question: how sustainable is this spree of issuance? While most market participants are in a wait-and-see mode, the signs are not good, according to Joyce Liang, head of Asia Pacific credit research, at Bank of America. This is partly because the heavy supply means bond funds now have limited dry powder.
Liang points to the bank’s quarterly Asian credit investors survey, which found that accounts’ cash level has come down significantly since November, dropping from one of the highest levels in the past two years to below the three-year average at the end of January.
“That suggests investors have deployed a lot of cash, and unless we continue to see inflows, it will be difficult for the market to continue to rally,” Liang says.
There are other concerns. The first is investors appear to be coming more selective, leading some issuers to scrap deals after they have been announced. Debut dollar issuer Century Sunshine Group Holdings, for example, was forced to postpone a 1.5 year transaction in early February, despite offering investors 14% yield — one of the highest so far this year. The company is not a total stranger to the bond market, having previously issued in Singapore dollars.
Schroders’ George says credit selection will be “very critical” this year for investors, as the pressure to chase yield has returned. “Those who have been buying or are stuck with the weaker quality names [in exchange for yields] should be worried about the future performance of their holdings,” he says.
The market remains open and receptive to familiar and repeat issuers who have demonstrated healthy secondary market liquidity, but debut names are finding it harder, says Clifford Lee, head of fixed income, DBS Bank in Singapore. “Unless it’s a convincing credit that’s BBB or BB+ and above,” he says. “In our view, we will need a solid six months to pave the way for first-time and single-B to come to market.”
“What the market is trying to differentiate now are the liquid and illiquid names,” says Lee. “For a high-yield issuer, as long as it displays robust liquidity in the secondary market, it is more attractive than the low-yielding names as everyone wants yield.”
Refinancing has become a key concern. Having become the most frequent issuers in the offshore market while continuing to borrow onshore where they can, Chinese developers have accumulated $74bn worth of bonds that will either mature or look likely to be putted in 2019, according to Barclays, which expects the offshore market to help refinance some of the onshore maturities. (The numbers include offshore and onshore bonds, but only issuers with at least some offshore bond exposure have been included in the calculation.)
Although the close to $16bn offshore property bonds coming due this year is only around one fifth higher than what the market refinanced in 2018, the quality of the issuers of these bonds has not held up. The yield hunt that started in 2016 and peaked in 2017 granted many marginal credits access to the dollar bond market.
That implies that there will be pockets of stress and not everyone can, or will, get refinanced.
Asia has already seen a record $6bn of offshore bond defaults in 2018, from not only Noble Group, but also the likes of China Energy Reserve and Chemicals Group, China Singyes Solar Technologies, CEFC China Energy, Hsin Chong Group, Huachen Energy and Wuzhou International Holdings. There is more to come.
Credit analysts from the region forecast the number of default events in the dollar space in Asia this year to range from high single digits to low double digits, most of which are expected from the Chinese industrial universe.
In its 2019 outlook, JP Morgan’s credit research team saw high risks in some 10 issuers with $4.7bn bonds outstanding, while requiring a buffer for another $2bn for unforeseen circumstances due to low visibility on some unlisted high yield names whose issuance sizes are too small for coverage. They expect a 2.5% default rate for Asia this year, in line with what was seen in 2018.
Defaults already picked up in China’s domestic market in January and February, and some have resulted in cross-defaults on dollar bonds from China Huiyuan Juice and laminating filmmaker Kangde Xin Composite Material Group.
But Fredric Teng, head of high yield debt capital markets, Greater China and North Asia, at Standard Chartered, says he is not too alarmed by onshore defaults. “I don’t think it’s systemic. I would have been more worried if the defaults are from the larger issuers in the real estate market — the impact would be much broader,” he says. “But the market is comfortable that the onshore defaults are still contained, and for now at least, investors are willing to look more on the brighter side of things.”
Concerns have risen since late last year that Chinese defaults could spill over to sectors that had been considered as relatively safe, such as local government financing vehicles (LGFVs) and real estate. Qinghai Provincial Investment Group, having repaid two $300m bonds late last year despite refinancing woes, is already leading the charge for LGFVs, having skipped a coupon payment on February 22 for a $300m 7.25% 2020 note. (It has since paid investors back.)
With the unprecedented default in LGFVs, the question remains how likely it is for the property sector to see defaults in 2019, and how the market will take it.
There are red flags. Data compiled by ANZ showed that despite the market rally this year, there were 130 dollar bonds from Chinese issuers, worth more than $50bn, that were trading above a 10% yield on February 13. Among those are bonds maturing this year from Fantasia Holdings Group, Golden Wheel Tiandi Holdings, Guorui Properties, Hong Yang Group, Modern Land (China), Oceanwide Holdings (which brands itself as a conglomerate), Redco Properties Group, and Xinyuan Real Estate.
Guorui Properties was downgraded to CCC from B- by S&P Global Ratings in February, due to increasing execution risks in the developer’s plan to refinance $550m of offshore bonds, $250m of which are maturing on March 1 and $300m becoming puttable later in the month. The analysts said Guorui’s execution of its refinancing plan was slower than expected, and the company has left “little room for slippage”. Guorui got some breathing room when it raised $160m at the end of February.
The refinancing pressure has led to some desperate moves. Fujian Yango Group said on February 15 that it would increase the coupon on a $300m 2020 bond it issued in 2017, from 6.85% to 12%. The coupon hike takes effect on April 5, the date the notes will become puttable at 100. Bankers and analysts interpreted the unusual step as an attempt to avoid the put.
But while it is clear that some companies are under pressure, market participants are unable to agree on the probability they will see offshore property bonds default before the end of 2019.
BofA’s Liang says she and her team are not too concerned about the property sector. “We expect six to nine potential offshore defaults from Chinese non-property high yield issuers, but it’s not our base-case to see property defaults,” Liang says, seeking comfort from the fact that the few developers whose liquidity was stretched back in last November have managed to raise some money since.
“Even when the market was weak, because developers tend to be very asset-heavy, the weaker names were able to use their assets to get some secured financing albeit at a higher cost,” she says.
Owen Gallimore, corporate credit analyst at ANZ in Singapore, says there will be property defaults, but not on the same scale as the non-property sector. “We could see more than 10 defaults in the non-property side and within properties there will potentially be two to three odd defaults, but not a wave,” he says. “Property companies have fairly straight stories and there are rarely major surprises, so it’s not hard to predict which names would get into trouble. The issuers trading [stressed] are the ones to watch.”
DBS’s Lee can also see the likelihood of future developer defaults, but says that as long as the defaults remain contained within the smaller issuers, the market can “well absorb the shock”, putting the emphasis on secondary liquidity. Other bankers take an optimistic view.
“There were some concerns for the heavily-levered, smaller real estate names in the single-B space to refinance late last year, as some Chinese asset managers were winding down their investments,” StanChart’s Teng admitts. “But I really feel the storm has passed, and things are getting better.”
Look to the top
Brock Silvers, managing director at Kaiyuan Capital, a China investment advisory firm based in Shanghai, believes that the government’s role is the “primary determinant” for offshore real estate bond performance in 2019 and the possibility of defaults, given the Chinese economy’s dependence on the sector.
“Regulatory policy has become a primary driver for the sector and its debt obligations,” he wrote in an email to GlobalCapital Asia. “We’ll see defaults only if Beijing allows it, and it will probably depend upon the depth of the [Chinese economic] downturn. [The defaults] may not be contained to industrials, and Beijing may try to thread a difficult needle by allowing one to two real estate defaults without causing a cascade.”
“I think re-opening the domestic real estate bond market shows Beijing’s acknowledgement of developer liquidity woes. Authorities are trying hard to alleviate one problem without worsening another. But I suspect it may not be very effective. Beijing likely has some hard choices to make.”
Few market participants would say they want to see more Asian bond defaults. But there is an upside to any defaults that do happen: they will force investors to pay more attention to credit risk. In the long-run, that is good for the price-setting function of the market.
“There are weak players in the property sector that will be shaken out this year, as the market gets careful about not necessarily funding every issuer out there,” Schroders’ George says. “It will be a positive development because what we do not want is to see weak companies — which do not necessarily have good enough businesses to continue to survive — being supported.”
Defaults or no defaults, there are many challenges facing Chinese developers. BofA’s Liang voices her concern about some property issuers’ experience — or lack of — in capital markets. “Some developers only started coming to the market in the past two years and if these less experienced issuers prioritise costs over liquidity, they might miss the opportunity and the timing for refinancing. If they default, that will be the reason,” she says.
But it seems that issuers are gradually learning how to navigate the offshore market, one that was unfamiliar to them until only a few years ago. For example, bonds with a maturity shorter than one year — commonly referred to as 364-day bonds, though the actual maturity could also be 362 or 363 days — were popular among Chinese issuers in 2017. This led to a surge in short-term debt, but issuers have now learned the risks in selling short-term paper, says StanChart’s Teng.
For now at least, it does not look like Chinese developers are slowing down their offshore parade any time soon. It is anyone’s guess what comes next for Chinese offshore bond issuers, but market participants admit they are watching carefully.
“It has always been a concern of mine that developers may have grown too big for the offshore market to fund them,” says ANZ’s Gallimore. “If they keep coming offshore and their onshore funding doesn’t pick up, then we could see a sharp turning point where the offshore market has just had its fill — especially now that we know the headlines are not going to be great, with the slowdown in Chinese economy and defaults in the private sector.
“I won’t say it’s tenuous but we shouldn’t get overly confident about the market.”