China Builder Bonds Face New Risk as Buybacks Boost Leverage

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As Chinese developers use more money to buy back shares amid an equity rout, concern is increasing that the trend will leave less cash to pay back bondholders.

Evergrande Real Estate Group Ltd., China’s most indebted developer, on Tuesday bought back 127.7 million Hong Kong-listed shares for HK$679.5 million ($88 million), bringing total repurchases to HK$4.32 billion since July 8. China Vanke Co., the nation’s largest homebuilder, this month approved a plan to repurchase as much as 10 billion yuan ($1.6 billion) of its onshore shares.

The transactions show how Chinese companies have started to shift their focus from reducing debt levels to shoring up stock prices after a $4 trillion plunge in mainland equities. While authorities had been encouraging businesses to cut leverage, some firms are now doing the opposite as they seek to revive confidence among existing stockholders.

“The share buyback once again demonstrates Evergrande’s strong inclination to be shareholder-friendly, and is negative for the bondholders as it deploys cash to reduce the equity base and therefore increase gearing,” said Guo Rui, Hong Kong-based vice president at Guotai Junan Fund Management Ltd.

Calls to Evergrande’s public relations and investor relations departments went unanswered Tuesday.

Debt Financing

Dollar bonds issued by the builder of high-end apartments in cities including Guangzhou have dropped from the year’s high. The 8.75 percent notes due 2018 have fallen to about 95.5 cents on the dollar from 96.5 cents on July 20, which was the highest since August 2014. Its shares jumped 5.1 percent Tuesday to HK$5.32, the highest in almost two months.

The cash splurges in China come as the nation’s biggest developers step up local bond sales after Premier Li Keqiang loosened controls on their financings in the mainland. A Poly Real Estate Group Co. director also bought back shares this month after the securities regulator encouraged lenders to support repurchases. The deals add to a global wave as companies tap cheaper funds after central bank rate cuts to boost stock prices.

Evergrande sold 15 billion yuan of bonds on July 8 and 5 billion yuan of debt on June 19 to repay borrowings and replenish working capital, according to data compiled by Bloomberg.

Its share buyback may be partly funded by a May equity placement or previous bond issues, as net cash flow from core business is expected to remain the same as last year, said Toni Ho, an analyst at RHB OSK Securities Hong Kong Ltd.

‘Credit-Negative’

Chinese developers issued a record 67.1 billion yuan of notes in the second quarter, up from 44.4 billion yuan the previous three months.

Earlier this month, China’s securities regulator encouraged listed companies’ biggest shareholders, senior executives and directors to increase their stakes when shares plunge to help stabilize the market.

At least 1,300 major investors had boosted their holdings as of July 20 from July 8, when the China Securities Regulatory Commission issued its call to shareholders, the official Xinhua News Agency said, citing information from financial data provider Hithink Flush Information Network Co.

Evergrande plans to seek a new mandate to buy back up to 10 percent of its shares at an extraordinary general meeting of shareholders to be held in September. It had already won approval in June for an initial 10 percent stock repurchase.

“This would clearly be credit-negative news for bondholders,” said Ross Lee, credit desk analyst of Bank of China Hong Kong Ltd.

— With assistance by Judy Chen, and Lianting Tu

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