UOB Kay Hian Bond Radar
Policymakers at the US Federal Reserve raised rates by 0.25% in March, and expectations are for many more hikes before this cycle ends. Fed funds futures indicate that rates will peak in August 2023 at 3.0%. Future rate hikes are already reflected in the yield of Treasury notes. The 2- and 5-year maturities are yielding 2.3% and 2.55% respectively. As yields rise, bond prices have dropped. Risk appetite for corporate bonds, even investment-grade corporates, has been hurt by the Ukraine war. European bond issuers may face a tougher business environment and weaker profitability, potentially leading to wider credit spreads – interest on top of interbank rates that issuers need to pay for loans. When screening for investment grade (IG) bonds, our bond radar has steered away from issuers that are based in Europe. Business-wise, we look for issuers with their core business relatively shielded from the war.
Chinese Property Bonds: High Yield and Distressed
Chinese property bonds have been mixed as the better names rebounded on the back of the Chinese government's continuous support for a healthy property market and domestic economy. The weaker names could not attract much buying. There is a great deal of pessimism about how US dollar bondholders will fare if a company needs to restructure its debt. China Evergrande shares were suspended from trading ahead of debt restructuring plan to be finalized in July 2022. The current price of its US dollar bonds (around 10 cents) indicates there will not be much of a recovery for US dollar bondholders in a restructuring. Right now, the only strategy appears to be to focus on issuers that can avoid restructuring their debt. State-owned enterprises (“SOE”) like China Resources Land (1109 HK), and China Overseas (688 HK) are likely survivors. The market expects SOEs to take over and dominate the sector to better align with the “common prosperity” theme. Many mainland property developers are delaying their results announcements. HKEx has a policy that if a listed company with its financial year-end in December fails to post full-year results before 31 March in the following year, its shares will be suspended starting 1 April in the following year. Last year, Huarong (2799 HK) was suspended for 9 months and GCL-Poly Energy (3800 HK) was suspended for 7 months. As of 28 March 2022, China Evergrande (3333 HK), Kaisa (1638 HK), Sunshine 100 (2608 HK), China Aoyuan (3883 HK), and Sunac (1918 HK) are in this category. The list is likely to grow.
Why are so many Chinese property developers in distress?
Highly leveraged: We are in the midst of a liquidity crunch. Most non-SOE property developers are highly leveraged, and they are having trouble refinancing their debt.
Using short-term borrowing to fund long-term investment: Some developers have significant exposure to redevelopment projects. For example, rebuilding an old district in Guangzhou takes years, and if the company is relying on 1 to 3 years of financing, the developer will need to refinance the project before it completes. Commercial and Business District projects like modern complexes with offices, shopping malls, hotels, and serviced apartments mainly rely on rental income. It takes a long time to pay off the project.
Lack of positive cash flow: Developers mainly have cash flow from (1) operations (selling apartments), (2) investment proceeds (selling investments such as minority stakes in project companies, disposing of assets and investment properties including hotels), and (3) financing activities (bond issuance, bank borrowings). China property market sales have gone down year on year and offshore USD bond issuance activities for property developers have practically been frozen following China Evergrande’s default. Disposals of investments and assets are happening but not fast and large enough to compensate for the decrease in (1) and (2).
Off-balance sheet debt: Developers may have guaranteed the debt of special purpose vehicles. These hidden liabilities do not show up in their balance sheets and are not spelled out in their published financial reports.
Complex structures between the listed company and its project companies: The Hong Kong listed company could be the issuer or guarantor of the offshore USD bond and the money raised is being used by its subsidiaries on the mainland. Now, some or many of the subsidiaries are slow in paying back the parent company due to a slowdown in sales. The parent company fails to repay its bondholders but the bondholders struggle to claim the asset held by the mainland subsidiaries due to the complex shareholding structure and differences between onshore and offshore jurisdictions.