Investors drew a sharp intake of breath at the start of the year with the news that Kaisa Group, a Chinese property developer in the southern city of Shenzhen, had defaulted on a HK$400m (£34m) loan from HSBC and then missed a payment on its $500m offshore bond.
No Chinese property company owing money to foreign investors has gone belly-up before. Were it to do so it would be a step into uncharted territory with unknown repercussions for the wider real estate sector.
So, with international investors fretting about a possible chain reaction, owing to the possibility of a surge in funding costs and more Chinese property companies subsequently struggling to repay or refinance their debts, Chinese property stocks and bonds were understandably under a pall for the best part of last month.
However, such worries have since proved largely misplaced, with Kaisa avoiding a default at the 11th hour. Having secured a waiver from HSBC on its defaulted loan, Kaisa then made the most of the 30-day grace period that kicked in after it missed its bond payment on 8 January to attract interest from rival developer Sunac China Holdings.
Having first snapped up some of Kaisa’s Shanghai assets, giving Kaisa a cash injection, Sunac, based in the northern city of Tianjin, has now proposed a takeover of Kaisa.
However, a declaration this week from Kaisa that its debts now total more than HK$10bn – with half potentially due by the year end – has left some concerned that restructuring needs to take place to allow the Sunac rescue to proceed.
The significance of the Kaisa situation cannot be overplayed.
Defaults are a new thing for China’s planned-cum-capitalist economy. The first corporate bond default – by Chaori, a Shanghai-based maker of solar panels – occurred only last May.
It is a growing pain, a sign that the Chinese economy is evolving as the Beijing authorities try to instil greater market discipline, and evidence that investors in China should expect to suffer more of the consequences of their poor investment decisions.
With the Chinese government trying to manage a downshift in economic growth, from breakneck speed to something more sustainable and less credit-doped, it has a massive task on its hands to ensure a smooth transition.
New house prices in China have now fallen for five straight months as developers faced with more restrictive funding conditions slash prices to bring down their bloated inventories.
That is in spite of a surge in home sales towards the end of last year after the People’s Bank of China unexpectedly cut interest rates and lifted some lending restrictions.
With data showing China’s economy expanded by 7.4% in 2014 – the kind of growth developed countries dream of, but for China the slowest rate in 24 years – the PBOC last week also cut the reserve requirement ratio for Chinese banks, which are nervously running the rule over the property market, and with good reason.
“A protracted and deep property market downturn may present the single biggest threat to the banking system in China,” says Liao Qiang, a Beijing-based analyst at Standard & Poor’s.
Having lent vast amounts to developers, some banks have begun to shore up their capital base in anticipation of a jump in bad property loans. In China’s listed real estate sector there are now 135 companies with more debt than equity, compared with 57 in 2007, according to data compiled by Bloomberg.
Even so, Kaisa’s problems were well telegraphed and reasonably distinct. The company had already been subject to a sales ban from the Shenzhen government before its debt difficulties came to light.
The fallout was largely contained, even as the Kaisa drama was still unfolding. Some Chinese property shares underperformed, including Glorious Property Holdings and another Shenzhen-headquartered firm, Fantasia Holdings Group, both of which are Hong Kong-listed and have offshore dollar bonds maturing later this year.
But for all this jitteriness international investors did not stop piling into a HK$1.2bn double bond issue by Sino-Ocean Land, one of the largest developers in Beijing and a major property player nationwide.
eaker-credit Shimao Property also had no trouble raising HK$800m from bond investors a week later.
China remains the greatest urbanisation story ever told. More than half of China’s vast population now live in towns and cities, compared with less than a third two decades ago, and there is much more to come. By 2025, consultants at McKinsey & Company estimate that China will have 220 cities with more than a million inhabitants. Europe currently has 35.
What the Kaisa episode tells us is that it has probably never been more important for investors to take a more discriminating view of Chinese property.
William Kemble-Diaz writes for FinanceAsia
China special:
• Briefing: Chinese investment – a bigger piece of the pie
• Finance: View from China – Kaisa-ra sera
• 2015: A year of promise and prosperity
