Photographer: Qilai Shen/Bloomberg

Why the Dollar Bond Rally of Chinese Property Developers Might Be Short-Lived

A victim of its own success?

It's no secret that China's inflating property bubble is a growing headache for the country's leadership.

But concern about overheating real estate hasn't yet translated into pain in the international bond market where Chinese property developers raise a chunk of their funding. Having recorded negative net U.S. dollar-denominated bond issuance for four quarters in a row, Chinese property developers — a staple of the Asian high-yield bond market — finally saw the number turn positive in the third quarter of 2016, according to data compiled by CreditSights Inc.

This change in sentiment could prove short-lived, however, as Beijing attempts to cool property prices and as the shortage of international bonds sold by Chinese property developers begins to abate.

The recent rally "boils down to a combination of factors — improving track record of issuers; issuers turning onshore creating scarcity value offshore; booming property markets in the first half; and global investors seeking yields," Chuanyi Zhou, a credit analyst at Singapore-based Lucror Analytics, said in an interview.

property 3
Source: CreditSights

Sandra Chow, a Singapore-based senior analyst at CreditSights, agreed that the rally is driven more by technicals than fundamentals.

"Despite broader industry-based concerns, Chinese property has historically been one of the more defensive sectors within Asian high yield as the better issuers have good, tangible assets that can be sold in the event of financial distress," said Chow in an interview.

Chow added that Asian high yield issuance is no exception to global credit markets, which have performed well in recent months on the expectation that ultra low interest rates will continue, helping to push investors into relatively higher-yielding securities.

"Asian credit has benefited from fund inflows into emerging markets as investors seek higher yields," added Chow. "Also, dollar issuance from Asia has been low compared to historical levels as Chinese companies have been using domestic funding avenues instead."

This technical-driven funding condition has worked in favor of Chinese property issuers, who have been enjoying tightening spreads since the start of this year.

Source: Lucror

But the analysts reckon that those issuer-friendly days may soon be over, as investors are increasingly expressing fatigue with the asset class.

The tightening effect has already kicked in, according to CreditSights Analyst Matthew Phan, as the curbing measures "may be biting into returns" on China's property dollar offerings.

Phan reckons that those bonds, which had fared better against broader investment-grade and high-yield indexes from February, have started to show signs of relative weakness in September and October.

property 2
Source: CreditSights

Yuzhou Properties Co.'s $250 million notes sold last week is a good example, says Chow, as the dollar-denominated offering struggled to resonate well among primary investors and have seen lukewarm response in secondary market trading so far.

But Lucror's Zhou says she is more concerned about the approach taken by the authorities to tame property demand.  

"In our view, a property bubble is probably an over-generalized statement — it depends on which city we are talking about," said Zhou. "What concerns us more is the regulatory tightening implemented recently, which slows down the contracted sales that may in turn pressure the liquidity of some developers."

Beijing has recently rolled out a series of cooling measures in top tier cities, such as increasing minimum down-payments and restricting non-residential home purchases.

Chow concurs, saying that there are "signs of investor push-back emerging ... While investors still seem comfortable with stronger and larger developers with good contracted sales and adequate liquidity, we do expect a slowdown in the Chinese property sector next year."

She concludes that the extent of corrections hinges on how the government maintains "a careful balancing act" between reining in runaway home prices and protecting the property sector from a sharp downturn.

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