Specialists and analysts have all predicted that China property will be, again, a hot sector for the Asian bond markets this year. And the forecast is certainly panning out this quarter. Over the past week, Country Garden, Agile Property Holdings and Kaisa Group have all priced deals in the high-yield market. And, on April 14, Evergrande Real Estate (B1/BB) executed a $600 million private placement.
Left in the immediate pipeline is Glorious Property Holdings (provisional B1/B+), which went on the road at the beginning of this week, and Yanlord Land Group (Ba2/BB), which is expected to come to market this month. China Aoyuan Property Group is also expected to issue a high-yield bond this quarter.
The driving force behind these firms pricing high-yield deals is a combination of tighter regulations in the domestic market and a change in market fundamentals that are pushing these companies to sell debt offshore.
The case for high yield can be explained simply. "Investors feel that the Chinese property development sector is risky because of the volatility in the domestic market compared to other sectors," said Kaven Tsang, an analyst with Moody's Investors Service. As a result, there is demand for a risk premium compared to other local infrastructure sectors, which is typically factored into price.
And because of the strong supply in the market, there is competition. "If a developer wants funding from investors, they should expect to pay a certain premium to affect demand," said Tsang. Under these conditions it would therefore be difficult to attain a lower funding cost in comparison to the other more stable sectors.
Timing
Fergus Edwards, head of syndicate at UBS, said the surge of property names coming to market was very independent to the issue of future interest rate hikes and expected increases in inflation. "This is not a question of relative government yields and interest rate projections making offshore borrowing marginally more desirable than onshore," said Edwards. "This is a high-yield market that was closed at ratings just below investment grade for many months and is now reopening at a higher yield."
"There is a long list of potential borrowers within the China property sector that have all been looking at the market over the last two years; it is only now that investors are willing to look at them," he added.
Given the expansionary mode that these companies are in, it makes sense that they will be seeking funding to fuel their growth. And thanks to regulatory measures in the domestic market, they will naturally go offshore to try and cover their capital expenditure requirements.
In terms of timing, it is not a case of 'why now?' Issuers have been waiting for market conditions to be supportive for some time. As one banker close to the Agile deal said, "the high-yield market is looking pretty good right now, so timing is appropriate".
There is also another motivation for Chinese property developers to raise offshore financing through the debt markets. "It's a natural move, especially for those Chinese developers that floated their IPOs late last year, to launch offshore bonds to help refinance their existing costly pre-IPO loans currently residing on their books," said Vince Chan, credit strategist at Amias Berman & Co.
Regulatory tightening
The increased liquidity in the bond markets, coupled with the improved performance of the property developers, are working counter to government efforts to control property prices and the overall growth in the sector. As such, there is still talk that the property market may be at risk of overheating.
On March 31, the China NDRC Property Index posted an 11.7% year-on-year rise in property prices, indicating that regulatory measures are not proving to be as effective as the government had planned (see chart).
Source: Bloomberg
In terms of the long-term prospects, the property market is being fundamentally driven by urbanisation. In particular, people moving from the undeveloped parts of China to tier-one cities such as Beijing, Shanghai and Guangzhou. To support this urban migration, regulators want funds extended to real money investors, which are typically first-home buyers moving away from the rural areas. But what is actually happening is that the market is instead being driven by the more mature home buyers.
To control speculation, the government has increased the proportion of down payments and raised mortgage rates for buyers of second and third homes. For instance, second-home buyers are expected to make a minimum down payment of 50% (up from 40%) of the purchase price, whereas third-home buyers are expected to make a down payment of up to 60%.
With the short-term uncertainty related to regulatory reforms, the market is favouring credit over equity holders. Any further equity issuance will dilute existing shareholdings, making the bond market more attractive.
And since Beijing banned real estate companies from raising capital via the equity markets early this year, the bond market has become the only fundraising channel for Chinese property companies. The Chinese government also ordered state-run banks to suspend property-related financing for corporate borrowers.
However, with continuing suspicion about corporate governance practices and transparency, coupled with regulatory-induced volatility, there is still a question mark over how these credits will perform in the secondary market.
Bryan Lai, a credit analyst with Credit Agricole Corporate & Investment Bank, holds the view that the market has reached a threshold. Few of these companies are in a deleveraging mode or on the lookout for additional debt and covenant carve-outs for existing bonds and loans. "Looking at the credit valuation for a lot of these names, it would be very difficult for spreads to squeeze significantly tighter from where they are right now," Lai said.
Evergrande returned to the market with a $600 million private placement on April 14, following on from its $750 million five-year issue in January. And a day later Country Garden sold $550 million worth of high-yield bonds to fund a convertible bond tender.
The new Country Garden 2017 bonds have performed fairly so far, "supported by its operational track record and disciplined credit profile", said Chan at Amias Berman. "Evergrande, however, poses greater leverage risk given its heavy debt load."
Evergrande has so far raised $1.35 billion in bond financing this year. According to Chan, this heightened credit risk continues to be a drag on the relative bond performance, although the company's large, low-cost landbank and its leading market position in the Chinese real estate sector, offer attractive medium- and long-term value for investors.
Agile and Kaisa
Meanwhile, both Agile Property Holdings and Kaisa Group priced high-yield notes yesterday morning.
Kaisa printed $350 million of five-year senior guaranteed notes that pay a coupon of 13.5% and were priced at par. The maturity date for the bonds, which are rated B1 by Moody's and BB- by Standard & Poor's, has been set to April 28, 2015. They are callable after three years. Lead arrangers for the deal were Citi, Credit Suisse and UBS.
Bookrunners were able to secure a $620 million order book from 86 accounts. Asia was allocated 84% of the book in the final distribution, Europe received 11% and offshore US investors got 5%. Fund managers took 50% of the deal, private banks 47% and banks 3%.
This was a debut issue for Kaisa, and came on the back of a $445 million IPO in December 2009.
With a larger deal size of $650 million and a one-notch stronger credit rating (Ba3/BB), the new Agile 2017 bonds were able to draw a larger investor base than Kaisa with 330 accounts. The company also attracted $4 billion worth of orders. Similar to Kaisa, the majority of the deal went to Asia, which made up 58% of the allocation. Europe accounted for 23% and US investors represented 19%. Again, fund managers took the largest stake with 62%, banks accounted for 9%, insurance houses 7% and private banks coupled with other types of investors for the remaining 22%.
The Agile 2017s will mature on April 28, 2017 and are callable after four years. The senior unsecured debt priced at par and will pay a semi-annual coupon of 8.875%. Bookrunners were Bank of America Merrill Lynch, Morgan Stanley, Deutsche Bank and Standard Chartered.
Both Agile and Kaisa will use the proceeds for debt refinancing, land acquisition and property development, as well as for general corporate purposes.
"From a fundamental viewpoint, we are cautiously constructive on Agile given its defensive balance between land reserve diversity, product mix, operational efficiency and financial strength," said Chan.
Towards the close of yesterday's Asia session both bonds were trading around par to slightly above. The Kaisa 2015 bonds were quoted at 100.25 for a yield of 13.395%, while the Agile 2017s were quoted at a price of 100.375 to yield 8.82%.
High-yield deals are typically not quoted at a spread over Treasuries or swaps. Indeed some bankers view spreads to be irrelevant as bonds that price in the high-yield market are generally not hedged. Therefore dealers will look at the absolute yield to measure performance.
