The growing debt of Chinese real estate developers and junk bonds

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A pedestrian crosses a road in front of residential buildings in Beijing, China.Qilai Shen | Bloomberg | Getty Images

SINGAPORE – The growing indebtedness of Chinese real estate developers is once again in the spotlight, as liquidity issues at leading developer China Evergrande raise concerns among investors.Real estate prices in China have rebounded quickly as the economy reopened after the worst of the pandemic hit. Yet the authorities should formally curb promoters’ borrowing costs – setting rules that cap their debt ratios to their cash flow, assets and capital levels.

A document leaked last month regarding the cash flow of Evergrande, China’s second-largest developer in terms of sales, further highlighted concerns about Chinese developers’ cash flow.

Analysts warn that this has also increased pressure on the ability of developers to repay debt in bond markets by 2021.

Chinese real estate developers are among the largest issuers of junk bonds in Asia, with a total of $ 46.23 billion issued last year, double the number of 2018, according to data from Refinitiv. Junk bonds are lower quality debt securities that carry a high risk of default and therefore generally carry higher interest rates to offset this risk.

Evergrande’s liquidity concerns

The leaked document suggested that China Evergrande sought government help due to a supposed cash flow crisis. The company has since denied the claims in the document.

Nevertheless, the giant of ratings S&P Global Ratings downgraded China Evergrande from “stable” to “negative”, explaining that its liquidity was weakening.

“We have revised the outlook to negative as Evergrande’s short-term debt continued to increase, in part due to its active acquisition of real estate projects. We previously expected the company to pay off its debt in the short term, especially given the difficult economic climate ”. the rating agency said.

The incident presents an event risk for the Chinese real estate market in the coming quarters. We cannot rule out the possibility that more developers will face challenges during the deleveraging process.

“In our view, Evergrande faces increasing challenges in improving its liquidity due to the size of its debt,” added S&P. As of June 30, it had short-term debt of 396 billion yuan ($ 58 billion), in part due to the intensification of land and project acquisitions as opportunities presented themselves during the pandemic, said the rating company.

Billions of dollars in debt owed

In a recent memo, ANZ Research said that the Evergrande incident, while unverified, “heightened market concerns” about Chinese developers’ cash conditions and debt ratio.

With the Chinese government also set to introduce rules that would force companies to limit their debt, this could pose even more problems for them, ANZ Research said.

“The incident presents event risk for the Chinese real estate market in the coming quarters,” he said, referring to China Evergrande. “We cannot rule out the possibility that more developers will face challenges during the deleveraging process. ”

Chinese real estate developers could face increasing pressure to repay bonds next year, analysts at ANZ say. ANZ Research Shows 526 billion yuan ($ 77.46 billion) of onshore bonds will mature in 2021, 16% more than those due this year; while some $ 50 billion in offshore dollar bonds are also due next year, 47% more than this year.

Impact of the new rules on the real estate sector

Tens of billions of dollars in bonds are expected to mature next year, and analysts warn that in such a tightening of funding conditions, developers who must reissue bonds to raise cash could face hurdles.

“The new regulations could limit the ability of developers to repay their debts, fueling a demand for liquidity and slowing the activity of real estate investment,” said the note from ANZ Research.

Christopher Yip, senior director of corporate ratings at S&P Global Ratings, told CNBC that limiting growth in bank lending could reduce growth prospects, especially for more aggressive players.

“The dollar refinancing needs are higher than ever for the industry by 2021,” said Yip, who added that issuers could also face low investor appetite.

Capital Economics also said in a note: “The speed at which Chinese officials have moved from a crisis response to another round of restrictions on real estate developers has surprised many. ”

“For a leadership concerned with credit risks, the motivation is clear: real estate developers are responsible for all of the increase in indebtedness of listed companies in China over the past decade,” he said. he declares.

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