Safe as houses

Defaulted on a bond last week

Times are tough in China’s property sector. But might they be offering a major opportunity to the bravest of bond investors?

Many of the bonds issued by debt-laden property firms, especially in the offshore market, have dropped into the junk category following Sunac’s default last week. One of the top five developers in terms of home sales, it stunned investors by missing $29.5 million in interest payments on a $750 million offshore bond. A fuller failure could trigger cross-default provisions on all the $7.7 billion of bonds Sunac has issued in international markets, Reuters reported. The company has already missed four dollar coupon payments since April, with three of them treading water in grace periods.

Offshore bondholders won’t have been delighted that Sunac then paid out some local bondholders soon afterwards. Analysts say this is another sign that Chinese firms are going to prioritise repayment of domestic creditors – which typically include the larger state-backed financial firms – ahead of overseas investors.

Indebted firms in the sector such as Sunac have been in crisis since the central government imposed its so-called ‘three red lines’ in 2020 as part of efforts to deleverage the industry. The rules restrict all of the biggest private sector homebuilders from raising new debt in order to meet existing commitments. In a bid to survive the cash crunch companies have been rushing to offload units in completed projects.

The problem is that they are having trouble finding the funds to complete yet-to-be-finished projects. And for units already on the market, demand has dwindled from buyers, because of the government’s   zero-Covid policies.

Yet just when bond investors have been anticipating more dramatic events – including the potential collapse of China Evergrande, the world’s most indebted developer – the government seems to have reversed course and thrown a financial lifeline to the likes of Evergrande and Sunac.

The People’s Bank of China said on Sunday that Chinese lenders are now allowed to cut mortgage rates by up to 20 basis points for first-time buyers. The reduction isn’t a drastic one but it has sent a signal that regulators are worried that a wider meltdown across the property market would weigh heavily on a faltering economy.

Chinese media outlets also reported this week that three developers – Country Garden, Longfor and Midea Real Estate – have been informed by regulators that they have been selected as “model property firms”.

This new designation means they are presumed to be healthy enough financially to issue new bonds. The trio responded quickly, announcing plans to issue domestic paper expected to raise a combined Rmb2 billion ($295 million).

Chinese lenders and state-backed asset managers (or AMCs) might also come to the rescue of some of the biggest strugglers in the sector. According to 21CN Business Herald, senior officials held talks late last month with the big four AMCs and 18 banks at which a list of 12 of the most highly leveraged developers was presented. Also handed out was a set of guidelines on purchasing distressed assets from these troubled entities.

Both the Wall Street Journal and the Financial Times have reported that political leaders in Beijing seem divided on whether to ease the pressure on the real estate sector. But a further slowdown poses risks to growth ahead of the all-important Party Congress in October or November this year.  It will also make it harder for the economy to recover from the chilling impact of Covid-containment efforts in many cities. 

If financial conditions improve, the strongest property firms will have a chance to take fuller advantage. Some of the state-backed developers, who have been hunting for bargains in the portfolios of their more afflicted private-sector counterparts, might emerge as the biggest winners.

This may explain the outperformance of stocks like China Overseas Land, which has climbed more than 30% so far this year. Yuexiu Property, a Guangdong-focused developer that is reportedly involved in Evergrande’s restructuring plan, has also gained nearly 20%.

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