World’s Worst Real Estate Bonds Targeted in Crunch

China’s builders have been the world’s worst-performing real-estate bonds this quarter as Premier Li Keqiang allowed a record cash crunch to rebalance the economy away from property investment.

Dollar-denominated notes sold by Chinese developers have lost 4.1 percent this quarter, the most since the three months ended Sept. 30, 2011 and the worst among peers in major economies in Bank of America Corp.’s Global Corporates Real Estate Index. That marks a reversal after the debt topped 2012 rankings with a 22 percent return. Australian builders lost 0.8 percent since March 31, while Japan’s shed 1.7 percent.

China is seeking to tighten control on real-estate lending and expand property-tax trials to more cities after a three-year campaign failed to damp prices. Data released this month showed lopsided development in the world’s second-largest economy with manufacturing contracting and exports slowing while home prices jumped the most since December.

“We have some doubt on Chinese growth momentum and are worried about its credit leverage,” said Kim Jin Ha, the Seoul-based head of global fixed-income at Mirae Asset Global Investments Co. “If policy makers want to keep leverage under control, the property sector could come under further pressure.”

Mirae, which manages $55 billion globally, has kept an underweight position on Chinese developers this year and “hasn’t played in that space for a long time,” Kim said in an interview on June 19.

Rising Yields

Losses deepened this month amid a cash crunch that sent benchmark interbank lending rates to the highest since at least May 2006. Global investors pulled $6.9 billion from emerging-market debt funds in the four weeks through June 19, according to EPFR Global data. Bonds tumbled worldwide after Federal Reserve Chairman Ben S. Bernanke said last week the central bank may end its bond purchase program by mid-2014.

“The selloff in Treasuries has led to a correction in the whole Asian credit market,” said Leong Wai Hoong, who invests in high-yield debt in Singapore at Nikko Asset Management Co. “It has caused a revaluation of the whole asset class, and not just the Chinese property sector.”

Yuexiu Property Co.’s notes maturing in January 2023 tumbled 8.4 percent this quarter. China Central Real Estate Ltd.’s June 2018 callable notes have also slumped 8.4 percent while the November 2022 bonds of China Overseas Land & Investment Ltd. dropped 8 percent.

Home Prices

Yields on Chinese real estate bonds have jumped 98 basis points this quarter to 8.54 percent, the highest since Nov. 23 and up from a record-low of 6.96 percent on May 10, based on the weighted average rate of 80 straight bonds tracked by Deutsche Bank AG.

New home prices cost more in 69 of 70 cities tracked by the government in May from a year earlier, official data showed on June 18. Prices rose by 6.9 percent on average last month, according to a survey of 100 cities published on June 7 by SouFun Holdings Ltd., the country’s biggest real estate website owner.

“Should home prices continue to go up, we do not rule out the risk of further policy tightening in the property sector,” Jacphanie Cheung, a Hong Kong-based credit analyst at Deutsche Bank, said in an interview on June 19. Those curbs may include limits on pre-sale permits and home mortgages, she said.

Delayed Sales

China is already struggling with tighter liquidity and the current policy will choke credit expansion more noticeably for the rest of 2013, Fitch Ratings said in a June 21 statement. Chinese companies delayed almost 7 billion yuan ($1.1 billion) of bond sales last week. Local governments and developers are at risk of funding pains, Nomura Holdings Inc. said.

The one-day repurchase rate touched an unprecedented high of 13.91 percent on June 20, prompting speculation the central bank was forced to pump liquidity, before diving the next day by the most since 2007. There’s a reasonable amount of liquidity in the financial system and lenders should control risks from credit expansion, the central bank said in a statement dated June 17 and published on its website today in Beijing.

The government’s broadest measure of credit rose 58 percent to a record $1 trillion in the first quarter, with the increase driven by shadow-banking transactions such as trust loans. Bank lending for projects in industries with overcapacity must be banned, the State Council said after a June 19 meeting.

Leverage Concerns

The pullback in property bonds wasn’t triggered by a breakdown in company fundamentals, according to Carman Wong, head of emerging-market debt in Hong Kong at ABN Amro Private Banking.

“Valuations were expensive before the latest selloff, and leverage among the bigger companies remains at comfortable levels,” Wong said in a phone interview on June 20. Her firm manages $18 billion in Asia and Middle East. “We are not getting out of this sector.”

China’s cash crunch has pushed up bond risk. Credit-default swaps for five years surged to 134 basis points on June 20, the highest in more than 12 months, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market.

Contracts on bonds of Agile Property Holdings Ltd., the builder based in the southern Chinese city of Guangzhou, rose to an 11-week high of 701 on June 11, CMA data show. The cost of insuring the debt of Hong Kong-based Shimao Property Holdings Ltd. has risen 53 from a two-year low of 639 on May 7.

Changing Preferences

The yield on China’s 10-year government bonds touched 3.7 percent on June 20, the highest since November 2011, Chinabond data show. The yuan was at 6.1376 per dollar as of 12:49 p.m. today in Shanghai, according to China Foreign Exchange Trade System prices.

While Chinese developers have sold $13.5 billion of dollar-denominated bonds this year, surpassing the $10.5 billion in all of 2012, no company has tapped the market since Central China Real Estate Ltd. issued $400 million five-year bonds on June 4, according to data compiled by Bloomberg.

The slump has vindicated analysts from Morgan Stanley to Deutsche Bank AG, who reduced their recommendation on the sector since late last year, citing concerns about the economic slowdown and leverage.

“The bullishness in the market has clearly changed this year and for us, the overweight on the property sector has also been cut down in favor of holding more high-grade and cash,” said Nikko Asset Management’s Leong.

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