China Real Estate Bubble Bursts in Bond Market: Credit Markets

Workers labor on a construction site in Shanghai
Workers labor on a construction site for a residential development in Shanghai. Photographer: Qilai Shen/Bloomberg

Dollar bonds sold by China real estate companies this year are the worst performers among Asian non-financial corporate debt denominated in the U.S. currency amid concern the nation’s property market is overheating.

Yields on the $3.9 billion of bonds issued by Kaisa Group Holdings Ltd., Country Garden Holdings Co. and seven other developers since January widened by an average 2.26 percentage points relative to Treasuries as of last week, according to data compiled by Bloomberg. That’s more than the 2.05 percentage-point increase in spreads for the seven dollar-denominated bonds sold by other companies in Asia outside Japan.

Investors are demanding greater yields to lend to China property firms, a sign they expect borrowers will have a harder time meeting debt payments amid a government clampdown down on lending. Goldman Sachs Group Inc. and Credit Suisse Group AG cut their profit estimates for Chinese real estate companies after a 12.8 percent jump in real estate prices in April from a year earlier spurred the state to increase regulation.

“New issues by Chinese developers will stall for the time being,” Vince Chan, the Hong Kong-based chief credit strategist with Amias Berman & Co. LLP, a fixed-income advisory and brokerage firm founded by two former Citigroup Inc. bankers, said in a phone interview. “Investors need handsome rewards for getting exposed to weaker fundamentals.”

Widening Spreads

The amount of dollar bonds issued by China developers represents 45 percent of all corporate dollar debt sales in Asia outside Japan this year, Bloomberg data show. The yield spread on $350 million of 13.5 percent notes sold by Shenzhen-based Kaisa last month widened the most of the nine issues, expanding to 16.52 percentage points from 11.07 percentage points, Nomura Holdings Inc. prices on Bloomberg show.

Kaisa is developing 18 projects in Shenzhen, Dongguan and other cities in the Pearl River Delta, most of them high-rise residential complexes that combine recreational and commercial space, according to its website. An investor who bought the company’s 2015 bonds at par would have lost 15.5 percent.

Elsewhere in credit markets, the extra yield investors demand to own company debt instead of Treasuries rose 5 basis points last week to 193 basis points, or 1.93 percentage points, Bank of America Merrill Lynch index data show. The spread, which peaked at 511 on March 30, 2009, widened from this year’s low of 142 on April 21. Average yields rose to 4.06 percent, the highest based on weekly closes since the period ended March 5.

Sales Slow

Corporate bond issuance worldwide slowed this month to $66.1 billion, down from $183 billion in April and the least since December 2000, according to data compiled by Bloomberg.

“Companies have to be prepared to strike and strike quickly,” Rick Martin, the London-based director of treasury at Virgin Media Inc., the U.K.’s second-largest pay-television company, said at a May 28 briefing in London. “The key is to have the team ready and primed and able to pull the trigger at short notice. I can’t think of a time when the forces have been so polarizing.”

The cost to insure U.S. corporate debt against default rose. Credit-default swaps on the Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses or to speculate on creditworthiness, increased 25.1 basis points this month to a mid-price of 117.2 basis points. The index typically rises as investor confidence deteriorates and falls as it improves.

Asia Bond Risk

Bond risk rose in Asia today, with the Markit iTraxx Asia index increasing by 2 basis points to 135 as of 3:40 p.m. in Singapore, according to Royal Bank of Scotland Group Plc. The index has surged 32.4 basis points this month, heading for its biggest monthly jump since February 2009, prices from CMA DataVision in New York show.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

In emerging markets, spreads narrowed 16 basis points last week to 321 basis points, trimming the monthly increase to 63, according to the JPMorgan Emerging Market Bond Index. The world will increasingly depend on emerging markets to maintain growth and stability, Federal Reserve Chairman Ben S. Bernanke said in prepared remarks to a Bank of Korea conference in Seoul today.

Federal Reserve Bank of Chicago President Charles Evans told reporters in Seoul that he “wouldn’t be surprised” if the Fed’s policy of keeping rates low “gets extended just a little bit” by Europe’s sovereign debt crisis.

Interbank Rates

The rate banks say they pay for three-month dollar loans fell in Asia for the first time in 13 days as concern about Europe eased, helping arrest a flight to dollars by global funds. The Singapore three-month interbank rate for U.S. dollars, or Sibor, slid to 0.541 percent, according to the 11:30 a.m. fixing by the Association of Banks in Singapore. The rate reached 0.547 percent on May 27, the highest since July 8, 2009.

China has added to regulations designed to cool the property market several times this year, including raising banks’ reserve requirements three times since January, restricting pre-sales by developers and curbing loans for third-home purchases. It also raised minimum mortgage rates and tightened down-payment requirements for second homes.

Shanghai’s plan to begin a tax on residential real estate was submitted to the central government for review, the China Securities Journal reported today, citing unidentified people.

China Clampdown

Goldman Sachs lowered its 2010 net income estimates for Chinese developers by an average 13 percent and reduced earnings forecasts for the next two years by 25 percent, analysts led by Yi Wang wrote in a May 19 report. Credit Suisse pared earnings-per-share estimates by as much as 15 percent for 2010 and 20 percent for 2011, citing the government’s clampdown.

“With the negative headlines coming out of this sector, investors are less likely to be drawn to participate in new issues because of a high coupon,” Tan Chew May, a credit analyst for Aberdeen Asset Management Asia Ltd., which oversees $1.5 billion of Asian dollar debt, said in a phone interview from Singapore. “With the trend of widening spreads, new names are forced to come at premium.”

China property developers paid coupons as high as 14 percent to issue dollar debt this year, compared with an average 9.2 percent for other companies in Asia and 6.2 percent for U.S. property companies. On average, Chinese property companies are paying a 10.875 percent coupon.

Poor Conditions

Glorious Property Holdings Ltd., which has 26 real estate projects in cities including Shanghai, Beijing, Harbin and Changchun, postponed its first sale of dollar-denominated bonds in April. The Hong Kong-listed company cited poor credit market conditions for the delay.

Renhe Commercial Holdings Co., a developer of underground shopping centers based in Harbin, China, sold five-year, 11.75 percent dollar notes on May 18 to yield 974 basis points more than Treasuries after delaying the sale for two weeks.

The relatively strong finances of China developers means some companies can afford to pay double-digit coupons, according to Andy Mantel, Hong Kong-based founder of hedge fund manager Pacific Sun Investment Management Ltd.

Country Garden, which builds villas, townhouses and apartments in China, sold bonds in April with an 11.25 percent coupon. The company, controlled by China’s second-richest woman, Yang Huiyan, said contracted revenue in the first quarter rose 82 percent on sales in the Guangdong area.

Coupon Payments

“The sector is relatively better financed than it was two years ago when there were serious liquidity issues,” Mantel said in a phone interview. “Investors might not make any money on the actual bond, but they’ll get their interest payments.”

Fantasia Holdings Group Co.’s $120 million of five-year bonds pay the highest coupon at 14 percent. The company develops commercial and residential complexes in China’s Pearl River Delta and Chengdu-Chongqing Economic Zone regions.

It raised HK$3.18 billion ($408 million) from an initial share sale in Hong Kong in November, boosting cash reserves to $497 million from a deficit, Bloomberg data show.

“Sales and pre-sales have increased cash balances for most companies by over 20 to 30 percent while fresh debt issuance has extended maturity profiles,” analysts led by Raghav Bhandari at CreditSights Asia Research Ltd. wrote in a note to clients May 20. “Companies are in a much better position to handle this period of strain than they were a year ago.”


“People are attracted by the high coupons of the sector, but are fearful of the regulatory announcements and how it might affect the credits,” Sean Henderson, head of Asia debt syndication at HSBC Holdings Plc, said in a phone interview from Hong Kong. “More recently, the overall market backdrop has taken the whole high-yield sector lower.”

The yield spread on speculative-grade company dollar bonds in Asia widened 174 basis points this month as of May 28, compared with 50 basis points for investment-grade companies, JPMorgan indexes show. High-yield debt is rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.

Credit-default swaps insuring against Country Garden defaulting on its debt rose 343 basis points to 10.39 percentage point this month through May 18. The contracts suggest investors are pricing in a 50 percent chance of default.

Similar contracts insuring Agile’s debt have soared 3.85 percentage points since mid-April, when China’s central bank pledged to implement new lending rules to cool real estate “madness.” At current rates investors are pricing in a 48 percent chance of default.

Chinese property bonds are unlikely “to recover meaningfully anytime soon,” Amias Berman’s Chan said. “If we start to see the regulatory measures taking effect in the next few months then there may be a reversal of fortunes. But optimistically I think it’ll be the third or fourth quarter before things stabilize.”

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