Euroweek high yield report: China real estate

Euroweek high yield report, July 2011

The Chinese real estate sector has become, by some distance, the mainstay of the Asian high yield industry. By May 27, Chinese property company issues accounted for US$4.55 billion in the dollar markets alone in 2011 – and that’s not counting their prolific issues in the dim sum RMB debt markets, or synthetic RMB issues settled in dollars.

It has reached this position mainly because of domestic circumstances: restrictions on how Chinese property groups can finance their developments have, to a large extent, forced them offshore. Chinese banks cannot loan money to local property companies if the use of proceeds is to purchase land. Developers can use profits to do so, but are restricted to the level of net income in any given year, leaving them with offshore or onshore capital raising as the best option to supplement net income for land purchases. On top of that, many Chinese property owners – typically with a chairman having a significant or majority interest – don’t feel that equity valuations today properly reflect the value of their companies. “Debt is a better option,” says Eric Greenberg, managing director, financing group and head of leveraged finance in Asia ex-Japan at Goldman Sachs.

These dynamics mean that high yield issuance from Chinese property companies will continue just as long as the limitations remain in place – on top of which, more property bonds are going to require refinancing in coming years for issuances from the last few years. “It will likely remain the largest single sector for high yield issuance out of Asia in the near to medium term,” Greenberg says.

For much of the year demand for this paper has appeared insatiable even when it has seemed illogical that the market should be able to absorb so much supply. When Longfor Properties hit the road in March, for example, it was following real estate dollar issues by China South City, Hopson Development, Country Garden (for some $900 million), Shimao, KWG Property and Yanlord in previous weeks. There was a lot of talk about oversupply. “Longfor came at a time when people thought real estate issuance was highly saturated,” recalls Terence Chia at Citi, who was on the deal. “But they received a $7 billion order book for a $750 million deal.” They have been followed, too, by more of the same: SPG Land Holdings, Franshion Development, Guangzhou R&F (in a dollar and RMB combination), Sino-ocean Land. And all the while, other real estate issuers have been doing unprecedented things in RMB bonds at the same time.  “The size that Evergrande have achieved in synthetic RMB is phenomenal: US$1.4 billion equivalent, which is by far the largest Regulation S deal ever seen for a high yield credit,” Chia says [see the issuer roundtable for more on this deal].

It’s been interesting, though, that Chinese real estate is no longer the whole story for Chinese issuance. In fact, according to Bloomberg, by May 27 US$9.925 billion had been issued by Chinese high yield corporate issuers in 2011 to date, meaning that while real estate is comfortably the biggest chunk of the market, it’s no longer the whole story. So far in 2011 there have been dollar issues from manufacturing (Techong Textile, China Liansu), construction materials (West China Cement, China Shanshui Cement), natural resources (Winsway Coking Coal), energy (China Resources Power), industrial production (Hyva Global) and conglomerates (Citic Pacific and Fuson). “Real estate has obviously been a very significant component of overall issuance, and will continue to be because there is obviously significant demand for housing in a huge economy with a very large population,” says Rod Sykes at HSBC. “But I do think we will see an increasing proportion of issuers not from that segment of the market. They may be industrials, manufacturers, retailers. In the RMB market, for instance, we’ve seen renewable energy and retail recently.”

Although these sectors do not have the same regulatory circumstances to push them offshore, there are other national and international considerations that cause it to make sense. Domestically, the main reason is a shift in the availability of onshore capital. “In Greater China historically local liquidity was very strong, and only companies in a tough situation onshore would be prepared to pay up for the offshore market,” says Augusto King, co-head of debt capital markets for Asia at RBS. Tightened local liquidity has changed that, he says. “In the past, if an SOE made a big acquisition, they’d just call up a big local Chinese bank and be funded with big, long-term loans. That’s no longer happening and that is what is driving momentum: the liquidity squeeze in China making domestic costs very high.”

And internationally, it’s the expected movement of the RMB that makes the difference. To some, this is the bigger driver. “Onshore liquidity tightening for the major players is not a huge deal: they could still borrow from the banks if they want to,” says Simon Moore, credit analyst for non-Japan Asia at Credit Suisse. “But if they take a view on the currency, as they all do, then dollar funding makes a lot of sense. The NDF market says 2.5% appreciation, some people say 5; either way there’s a nice tailwind from an issuer perspective.”

Others agree. “China high yield is more than 50% of all deals getting done in Asia, which can be attributed to the tighter monetary policy onshore and a perception that, in an environment where the RMB will appreciate against the dollar, issuers get a benefit from dollar liabilities,” says Herman van den Wall Bake, head of global risk syndicate for Asia at Deutsche Bank. “But when it comes to how sustainable this is, that’s a harder question. Clearly there will be a point in the cycle when China loosens monetary policy, and the incentive to look offshore will change accordingly. And once issuers believe CNH appreciation has panned out, they may no longer be as keen to establish dollar liability.”

Indeed, there is a sense that momentum in China issuance may have peaked, particularly for real estate issuers. “My sense is the bulk of it is behind us,” says Moore. “If you look at the largest issuers, excepting Vanke and a few others, most have dollar bonds in the market already. But if we’ve learned anything, it’s that these guys are pretty opportunistic issuers. A key variable for the rest of this year is investor demand, not the amount of potential supply.”There is, though, a growing concern about a bubble in Chinese real estate issues, allied with an uncertain environment for recovery; these themes are discussed in more detail in the structuring and restructuring chapters.

The CNH (offshore RMB) market is the subject of another Euroweek report so is not covered in great detail here, but clearly does represent an alternative for Chinese borrowers. “It’s a case of the issuers looking for the best market opportunity to issue into and choosing that,” says Henrik Raber, global head of debt capital markets at Standard Chartered. “Chinese issuers have the option of a dollar transaction or a synthetic CNH deal, and will choose the one with the best pricing and dynamics.”

While there are concerns about volumes in Chinese issuance, investors have so far remained comfortable given the associated yield: China South City and SPG Land Holdings both carried a 13.5% coupon, for example. “There is more supply than demand associated with China property issues,” says Greenberg. “That has caused this sector to trade at significant spread premiums to similar rated non property companies out of China. The extra yield has attracted a different type of money,” such as hedge funds and other investor groups seeking yield.

As always it’s a question of relative value, risk and reward. “If you are a high yield or emerging market investor, the yield differential on China property is enormous,” says Moore. “Clearly there are risks in this market, absolutely, but the relative value is huge. If you ask yourself are you being paid for these risks, in my view you are.”