Why Investors Are Fleeing China’s Investment-Grade Property Bonds
(Bloomberg Opinion) -- Even seemingly healthy Chinese real estate developers are getting dragged into the Evergrande mess.
The financial crisis at China’s biggest property developer has spread to companies with investment-grade debt, walloping firms like Country Garden Holdings Co., the nation’s largest builder. Are investors overreacting?
Probably not. Since China Evergrande Group nearly defaulted on its debt, local governments across the country have been taking a close look at the rules governing residential real estate development, in many cases tightening requirements for how much cash the builders need to keep on hand for ongoing projects. As regulators delve into developers’ holdings, investors are realizing how little they know about these businesses’ finances.
At the root of the problem is that apartments in China are often sold long before they are completed. For construction projects, developers take property loans from banks, capped at 40% of the total project cost for large commercial lenders. To fund the remainder, local governments often allow developers to put apartments on the market when construction is still in its early stages.
For the pre-sold units, consumers pay the full price of their homes, delivering a lump sum to escrow accounts. In theory, developers are only supposed to tap those holdings to pay construction bills, or when they have delivered the apartments to consumers. But in practice, developers often treat that pot of money as free cash to be used for things like debt repayments.
The trouble at Evergrande has cut down on the practice. As the giant developer struggles to deliver 1.6 million paid-for homes to buyers, local governments want more say in how escrow accounts are used.
Rules vary from city to city. In Beijing, developers are required to set aside only 10% of cash in the escrow accounts. But smaller cities are less lenient, asking for a cash buffer of as much as 40%. That has left developers operating in smaller markets without access to money they had hoped to use to pay their debts.
The amount of cash set aside can be substantial. For instance, Chongqing-based Jinke Properties Group told investors that as of September, half its 30 billion yuan ($7 billion) in cash was in escrow accounts, according to Debtwire. Shanghai-based Cifi Holdings Group Co. said that as of June, about 30% of its cash was in escrow.
Country Garden, whose debt Moody’s Investors Service Inc. has given its lowest investment grade, is in an especially difficult spot. More than 70% of its real estate portfolio is in China’s smaller cities. How will the developer repay its debt, then? The question will soon become urgent: Country Garden has a $1 billion convertible bond that investors can redeem in December, as well as $1.3 billion in bonds due next year.
The bond rout is deepening because of asymmetric information. We don’t know how much off-balance-sheet debt there is, or how much cash developers can deploy to repay investors. Investors are justifiably skittish. To stop the selloff, some honesty is perhaps in order?
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
©2021 Bloomberg L.P.