China Developers, Beware the Dollar's Lure

It makes sense for home builders to sell bonds onshore. If only offshore investors weren't so welcoming.

China's property developers are facing a funding conundrum. That great big ball of money that rolled into the onshore bond market earlier this year is rolling out again. Good news for shares -- the Shanghai Stock Exchange Property Index has rallied 7.3 percent this month -- but it's going to make raising funds in the domestic debt market more difficult.

News that initial public offerings will resume after a five-month freeze had immediate impact. The yield on 10-year sovereign notes climbed the most in two years Monday as investors began the switch out of debt and into equities. And rates on five-year, top-rated corporate securities jumped to 3.84 percent, the highest in two weeks.

This sucking out of funds comes at an inopportune time for home builders, many of whom have become largely reliant on the onshore debt market. Developers have sold $55.5 billion of yuan-denominated notes this year, more than they raised in the five years to 2014 combined.

On a Tear

Chinese developer onshore bond sales

Source: Bloomberg data

Gravitating toward the onshore market has made sense. The cost to service dollar debt is rising and, with higher interest rates approaching in the U.S., will continue to do so. The average coupon that developers are paying on their yuan bonds, meanwhile, has fallen to 4.91 percent this year from 6.69 percent in 2014.

Country Garden said in its first-half investor update that it plans to increase its onshore/offshore borrowing mix to 60:40 by the end of the year, from 53:47 currently. By the end of 2016, it intends to have that ratio at 70:30, to help minimize foreign-exchange risk.

Yet just as the onshore market gets less receptive, the offshore market is looking more welcoming.

Seven months after Kaisa became the first Chinese developer to default on dollar-denominated debt, the sector has emerged as a surprising winner among offshore high-yield notes. Returns have averaged 14.2 percent since Dec. 31 compared with 6.1 percent for junk securities generally in Asia, Bank of America Merrill Lynch indexes show.

Improving fundamentals are enticing offshore investors. Ratings companies acknowledge that developers' finances have strengthened since Premier Li Keqiang allowed them to sell more bonds in the domestic market and as China's interest rate cuts start to spur gains in new home sales.

It's going to be tempting for property companies to capitalize on this momentum, considering the money flowing out of domestic bonds could leave a large void. But attractive as it may be, borrowing dollars when traders are pricing in a 68 percent chance the Fed will raise interest rates next month -- and when most analysts are forecasting further declines for the yuan -- would be a risky solution.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Katrina Nicholas in Singapore at

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