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Chinese Developers Face Debt Reckoning After Boom

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09/27/2017 | 11:45am CEST
By Dominique Fong 

BEIJING--A wave of local-currency debt coming due next year alongside new stricter lending rules are bearing down on China's developers and posing a risk to the country's economy.

The twin threats combined with a widely expected property market slowdown portend a shift in fortunes for many home developers after they rode a housing boom and strong profits in this year's first half.

The volume of maturing yuan bonds will jump 64% in 2018 for home builders to at least 230 billion yuan ($35 billion), and rise another 87% the year after that, according to data provider Wind Information Co.

Meanwhile, many yuan bondholders have the option to demand early repayment starting next year and increasingly in 2019 and 2020. The scenario could force a wave of asset sales and deprive developers of cash to build new projects, leading to a further potential deterioration in their finances, credit analysts say.

How the real estate scenario plays out has major implications for China's economy, which investors watch closely for signs of the direction of global growth. The sector contributes to nearly one-third of China's overall growth, according to Moody's Investors Service.

The trends reflect in part Beijing's efforts in the past year to restrict home sales as it feared that an overheated market fueled by a surge of mortgage lending could burst and ripple across the economy. Now, worries are growing that the market may be slowing even more in parts of China than policy makers had hoped.

"This year's very strong sales in tier three cities is unlikely to be sustained," said Larry Hu, China economist at Macquarie Group. "For next year, they're going to enter a down cycle."

Developers also are likely to pay more dearly for debt after home prices slowed for three straight months this summer, save a few small cities. Last year, only about 25% of developers paid 6% or higher for their yuan bonds, according to Wind. This year the ratio is more than 33%. Credit analysts expect that to climb further.

Since many loans use property as collateral, declines in value could exacerbate any chain of defaults for yuan bonds, bank loans and China's informal, lightly-regulated lending sector, potentially infecting China's financial system.

"The wall of bonds is just one symptom of the whole problem," said Anne Stevenson-Yang, founder of J Capital Research.

Large developers such as China Evergrande Group, Sunac China Holdings and Guangzhou R&F Properties Co. prospered through China's property boom in recent years. But they also racked up debt to fund land purchases while monetary policy was looser and credit was cheaper. Five large developers hold nearly half the bonds and options coming due next year, according to Moody's.

However, as the economy continues to slow--the government targets about 6.5% GDP grow this year--some analysts wonder how vulnerable developers are.

The recent rules aimed at cooling the market are also constraining developers' ways of raising money. That, in turn, could discourage smaller ones from investing in new projects.

Regulations include property-buying controls in big Chinese cities, such as caps on new-home sales prices and higher down-payment ratios. Other rules limit yuan bond sales on mainland exchanges and ban private asset managers from engaging in certain types of debt financing for real estate. The likely result: slower home sales and a higher risk of defaults.

Smaller developers are particularly vulnerable because of their high debt loads, experts say. For example, the net debt of state-backed Yunnan Metropolitan Real Estate Development Co. is 57 times earnings before interest and taxes, according to research firm Granite Peak Advisory. The ratio is 37 times for Fuzhou-based commercial real-estate developer Tahoe Group Co., and more than 23 times for Shanghai-based Yango Group Co.

In comparison, the leverage for all mainland-listed developers is 6.4 times, and 4 times for all Chinese companies excluding financial institutions, according to Granite Peak Advisory.

Most developers have adequate liquidity if they can't refinance debt and must repay bonds in full with cash next year, Moody's says. But their ability to do so is weakening. Rated developers' cash was 1.6 times short-term debt coverage, compared with 2 times last year, S&P Global Ratings says.

Some moves are afoot to address the concerns. Evergrande pledged to cut its net debt ratio to 70% from 270% by 2020 after reporting a ninefold jump in half-year earnings. In central Hubei province, a state-assets regulator ordered state-owned enterprises to speed up construction and sales to quickly book the revenue and lower financial leverage.

Despite the risks to China's real-estate market, global investors have continued to pile into dollar-denominated bonds of Chinese developers. Those developers issued $58 billion offshore over the year through late August, the highest volume for the period since 2014, according to Dealogic.

Other investors however are avoiding the market altogether, concerned they aren't getting paid enough for the risk.

"Coupons have to be much higher than where we are now," said Jennifer James, head of corporate research for emerging market credit at Janus Henderson Investors, which holds the offshore debt of one Chinese developer. "Headwinds are too strong to warrant this kind of return."

Write to Dominique Fong at [email protected]

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