Kaisa Anti-Graft Losses Cut China Developer Bond Sales

Chinese property developers are having a hard time persuading investors that corruption probes won’t wreck more of their bonds.

Foreign currency issuance by the industry slid 53 percent to the equivalent of $3.5 billion in the first quarter from a year earlier, data compiled by Bloomberg show. Kaisa Group Holdings Ltd. notes are trading around 58 cents to the dollar as the company attempts to restructure its debt, those of Renhe Commercial Holdings Co. are about 84 and Evergrande Real Estate Group Ltd. around 92. Junk bonds sold by China’s builders lost 1.2 percent this year, while all such debt in Asia is little changed, Bank of America Merrill Lynch indexes show.

President Xi Jinping’s anti-graft drive, called the harshest since the 1949 founding of the People’s Republic of China by official Chinese media, adds to risks among developers which often rely on personal connections to secure land from the government. Kaisa has been probed for connections with a former official in the southern city of Shenzhen, where another builder Shenzhen Kingkey Group is now also being investigated, according to people familiar with the cases.

“Some investor appetite for the sector has been weighed down due to the anti-corruption risks that are hard to predict,” said Raymond Lee, a money manager in Sydney at Kapstream Capital Pty, which manages the equivalent of over $5.5 billion of assets. He added that issuance may recover as uncertainty clears up over the probes and larger developers will trade “with less anti-corruption or corporate governance premium” than lower-rated ones.

Yields Jump

The average yield on Chinese junk bonds in dollars has climbed 241 basis points to 10.58 percent from last year’s low of 8.17 percent in July, the Bank of America Merrill Lynch index shows. Property accounts for more securities than any other industry in the index. Average yields on speculative-grade securities worldwide have climbed 77 basis points to 6.65 percent in the same period.

The fight against graft in the housing industry is adding to broader strains in an economy whose 7.4 percent expansion last year was the slowest pace in more than two decades. Real estate and construction account for about 33 percent of gross domestic product, according to Rosealea Yao, an analyst at Gavekal Dragonomics in Beijing.

‘Preservation Mode’

New-home prices fell in 66 of the 70 cities tracked by the government in February from a month earlier, the National Bureau of Statistics, compared with 64 in January. That backdrop has helped send the cost to protect the nation’s debt from default up 9 basis points this year to a two-month high of 94.5 basis points, credit-default swap prices show. The yuan weakened 1.2 percent against the dollar in the past six months.

“The overall issuance this year from the China property sector will be lower because the whole industry is in balance sheet preservation mode,” said Owen Gallimore, Singapore-based head of credit strategy for Asia at Australia & New Zealand Banking Group Ltd.

Cheaper onshore funding as the central bank cuts interest rates is helping to limit any negative impact from the declining dollar-bond sales, Gallimore added. The People’s Bank of China has cut its interest rates twice since November. The PBOC has scope to respond further to economic growth that has tumbled “a bit” too much, Governor Zhou Xiaochuan said Sunday.

Kaisa Hangover

Speculation that authorities may ease monetary policy further along with any additional steps to support the slumping real estate industry should lure more global investors back to builder bonds, according to Shuncheng Zhang, associate director at Fitch Ratings in Shanghai. China should also control the pace of housing construction this year to limit oversupply, China Land and Resources News, a land ministry publication, said on its official microblog.

“We expect the market sentiment to improve as the sector stabilizes upon further easing by the central government,” said Shuncheng Zhang, associate director at Fitch in Shanghai.

Standard & Poor’s downgraded Kaisa to default last week after the troubled developer failed to make coupon payments on two of its dollar-denominated notes. If Kaisa doesn’t pay the about $52 million interest that was due March 18 and March 19 on its 2017 and 2018 notes, it would become the first Chinese real estate company to default on U.S. currency bonds. A near-default on its 2020 securities last month highlighted the relatively weak position of foreign investors in debt restructurings in Asia’s largest economy.

“Investors will keep shying away from lower-quality property developers from China even if they pay a high yield because of what’s going on with Kaisa,” said Desmond How, head of global capital management, fixed income, at Nomura Holdings Inc. “This is also because no one can ascertain the recovery value for Chinese property bonds if they go to default.”

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