Bondholders cheering last week's move by Chinese authorities to cut minimum mortgage down payments to the lowest ever should treat this latest development with some skepticism. Beijing's decision may accelerate residential sales -- which on the surface would seem a good thing for developers -- but it will also probably mean they'll have to buy more land. With the cost of new plots in the biggest cities near record highs, that almost certainly will mean taking on more debt.
Junk noteholders have the most to lose. Their securities logged some of the best returns among dollar debentures from Asia last year as home builders turned to the local bond market for funding, reducing the pressure new issuance has on outstanding paper. (The fact developers were also slowing new projects while keeping sales steady, therefore generating more cash to pay back debt, boosted the price of their bonds -- and their creditworthiness -- too.)
But there's an additional factor. China, as almost everyone knows, has a huge local-government debt problem. A 24 trillion yuan ($3.7 trillion) problem in fact, according to official news agency Xinhua. Although some of those liabilities are being refinanced in the local bond market, domestic fixed-income investors aren't an all encompassing silver bullet. Banks themselves meanwhile have enough issues of their own, with hedge fund manager Kyle Bass estimating the world's second-biggest economy may end up having to print more than $10 trillion of yuan to recapitalize lenders.
That's where home builders come in. Outside of remittances from Beijing, land sales are the biggest source of revenue for municipalities, making up more than one third of their income in 2013. Local governments need developers to be selling ever more apartments so they in turn can be selling them ever greater swathes of land. Little wonder then that mortgage rules have been eased three times since March last year.
Owen Gallimore, a Singapore-based credit analyst at ANZ, downgraded China's real estate sector to underweight in December, in large part because he expects land acquisitions to speed up, increasing the pressure on developers to sell more bonds. While local markets will bear some of the brunt of such issuance, developers will probably have to tap international investors at some point.
When they do, it's a pretty sure bet that existing bond yields will rise. Home builders may therefore consider selling equity, which would weigh on share prices. Whatever the case, the bottom line for junk bondholders remains the same. Those outsized gains they enjoyed in 2015 are fast beginning to look like ancient history.
(An earlier version of this column was corrected to fix a currency conversion.)
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