China Default Silver Linings Seen in 100%-Plus Returns on Kaisa

  • Kaisa bonds lost 70%, then rallied 167% amid restructuring
  • Value Partners says developers don’t want to ‘scare’ investors

China’s first bond defaults are delivering relatively high recovery rates, providing the promise of profits for some investors.

Kaisa Group Holdings Ltd.’s 2018 notes lost 70 percent from their sale price to 29.6 cents on the dollar in January 2015, when it became the nation’s first developer to default on offshore bonds. A restructuring plan, approved by 96 percent of holders in May, helped the securities rally 169 percent to around 80. Renhe Commercial Holdings Co. offered 77 to 88 cents in a 2014 reorganization, while rival developer Greentown China Holdings Ltd. paid 85 in 2009.

Fund managers including Value Partners Group Ltd. and BFAM Partners were rewarded for buying Kaisa’s distressed notes and negotiating terms, a precedent that will boost confidence as the slowest economic growth in 25 years strains company finances. While at least 17 Chinese companies have defaulted onshore and four firms have failed to repay offshore bonds in the past two years, Value Partners fund manager Gordon Ip says each delinquency should be judged in the context of local politics and corporate balance sheets.

Better Recoveries

"The recovery rate is higher for Chinese builders, with at least 60 percent recovery historically," said Ip, whose fund is in a four-member committee that negotiated the Kaisa restructuring. "Chinese developers want to operate on a going-concern basis, so they would not want to scare international investors.”

Coal miner Hidili Industry International Development Ltd. also offered attractive terms, restructuring at 68 cents on the dollar in September 2014. That’s higher than the 40.9 percent average recovery rate for defaulted bonds worldwide in 2015, according to Moody’s Investors Service. Indonesia’s PT Berau Coal Energy is offering no more than 18 cents on the dollar in its latest buyback proposal.

“China has seen high recovery,” said Owen Gallimore, a credit analyst in Singapore at Australia & New Zealand Banking Group Ltd. "Indonesia has provided a plethora of single-digit and teens for recovery."

S&P Global Ratings said Chinese property companies offer higher recovery rates because they have "marketable" assets, such as Kaisa’s real estate in Shenzhen, where home prices jumped 62 percent in April from a year earlier.

‘Good Reputation’

“Chinese developers generally show willingness to pay off their debts because they want to maintain a good reputation among home buyers,” said Richard Cohen, head of credit for Asia Pacific at BNP Paribas SA in Hong Kong.

Total debt of 198 listed Chinese developers rose 31.4 percent to 3.1 trillion yuan, according to Bloomberg-compiled data based on their latest financial results. Their operating profit is only sufficient to cover 1.87 times of interest expenses, down from 3 times three years ago.

“Despite better property sales, Chinese developers’ financial health has worsened as they stepped up land acquisitions and expanded into non-property areas,” said Christopher Lee, chief ratings officer for Greater China at S&P in Hong Kong.

‘Case Study’

Kaisa showed no signs of distress before it defaulted. In late 2014, Shenzhen authorities blocked sales of some of its projects amid a regulatory probe.

While regulatory issues made Kaisa "the poster child for everything that scares Western investors," its bonds are still cheap, BFAM founder Benjamin Fuchs told a conference in Hong Kong last week. BFAM bought Kaisa notes before prices doubled and is part of a two-fund group pushing for even better terms. He didn’t respond to an e-mail seeking comment.

"The people who sold Kaisa at 90 cents are probably happy and for the people who sold at 30 it’s probably a different story," said Michel Lowy, co-founder and chief executive officer of SC Lowy, an independent fixed-income firm. "When you are an investor in the Chinese high-yield bond market, you need to know there are things you don’t know."

Average yields on high-yield dollar bonds from Chinese issuers declined 95 basis points this year to 7.58 percent, the lowest in more than three years, according to Bank of America Merrill Lynch indexes.

Kaisa’s recovery rate was relatively high, said Raymond Chia, Singapore-based head of credit research for Asia excluding Japan at Schroder Investment Management Ltd. 

“This is the first property restructuring since the issuance of the first overseas high-yield property bond from China in 2005, which would create a textbook case study,” he said.

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