Like a punishing pub crawl gone horribly wrong, the Chinese property sector keeps lurching along but in progressively worse shape. Developers keep dropping like barflies, and there will be one hell of a hangover to pay.
Shimao Group Holdings (SIOPF) (HK:0813) is the latest to fade. Standard & Poor's downgraded its debt today, given overall weakening in property demand. Shimao sales were down 32% in October compared with a year ago, far worse than the 5% decline seen in the first 10 months in total. The company's above-average profitability in property development will likely fall to bang average over the next 1 to 2 years, S&P says. Rising land costs are clashing with price caps in high-tier Chinese cities to eat into margins.
Shimao's share price soared 16.9% on Wednesday, although that still leaves them looking at a 55.0% loss for the year. The company said on Friday that it would be buying its own stocks and bonds in a bid to boost confidence, and that it will consider selling commercial and hotel properties if prices are good.
Shimao's bonds were at the lowest investment grade of BBB- prior to the S&P downgrade. Now they are in speculative territory, at BB+. Its bond maturing in July 2022 is trading at 73 cents on the dollar, well above the disastrous levels of China's most-troubled developers.
The U.S. Federal Reserve this week warned for the first time that problems in China's property market could affect the U.S. financial system. The Fed, in its twice-a-year Financial Stability Report, warned that the woes of Chinese developers could feed into a sharp tightening of global financial conditions, particularly in highly-indebted emerging markets.
With leverage high at small- and mid-size Chinese banks, and both businesses and local governments carrying large debt burdens, highly indebted companies can experience stress, particularly in the property sector. That's because pricing is stretched, suggesting a sudden correction in prices or a reduction in investor risk appetite could spill over into the broader Chinese financial system, the Fed believes. Given China's economic might and extensive trade links to the rest of the world, it could ultimately export these financial stresses into global financial markets, the Fed concludes, causing a deterioration in risk sentiment as well as global and U.S. growth.
Asian stocks moved lower on Wednesday, with investor sentiment knocked by day-before losses on Wall Street as well as the slow-rolling but persistent problems in Chinese property stocks. The CSI 300 of the largest stocks in mainland China fell 0.5% as investors fretted about future inflation, meaning it has fallen 2.7% in the last 12 months. The Hang Seng benchmark in Hong Kong rose 0.7% but is down 5.0% in the last year.
The Hang Seng was lifted in part by China-focused developers, in a relief rally. The Hang Seng Properties Index advanced 3.1% with hopes the China Evergrande Group (EGRNF) (HK:3333) will make yet another last-minute payment.
Kaisa Group Holdings (HK:1638), which asked for a trading suspension last Friday in the shares of its four listed subsidiaries, told a meeting it attended with a Chinese think tank, other developers and several banks that it needs help to pay loans, workers and suppliers, Reuters reports. Its halt remains in effect, and the company has not yet released whatever insider information it promised.
"We sincerely ask investors to give Kaisa Group more time and patience," the company said on its official WeChat account. It urged state-backed developers to help struggling private-sector rivals by buying their projects and other parts of their businesses.
Kaisa's bonds sold off as investors demonstrated little of that kind of faith and patience. Its bond coming due in July 2023 is trading at 28 cents on the dollar. Fitch downgraded its debt on Tuesday to CCC-, meaning default appears imminent, with little prospect for recovery. The next step down, DDD, means a bond borrower is in default. Fitch notes that Kaisa's liquidity keeps deteriorating, and the company has undeclared liabilities on the wealth-management products it has sold to fund projects.
Kaisa was the first Chinese company to default on an offshore bond, back in 2015. But its business appeared to have recovered. It has been brought to its knees by the Chinese government's crackdown on excessive leverage. Kaisa has around US$3.75 billion in debt due between now and the end of next year, Fitch calculates, and US$1 billion per year in interest payments alone after that.
The company has reportedly missed payments owed on the C¥12.7 billion (US$2.0 billion) in unreported wealth-management products that it has issued. Those shadowy quasi-investment products have been used by developers to raise money from apartment buyers, employees, you name it, sometimes to pay back contractors and other building suppliers so they will complete projects.
Kaisa has more offshore bonds, at US$19 billion, than any Chinese developer other than the company that kicked it all off, China Evergrande Group.
Evergrande has another overdue bond payment due on Wednesday, this time to the tune of US$148 million. Twice it has staved off default at the last minute, just beating the 30-day grace period before a missed payment becomes a hard default, which would trigger a string of cross-defaults among the group's companies.
It is unclear where the money came from to make prior US$47.5 million and US$83.5 million interest payments on other offshore bonds. The governments in Beijing and in Shenzhen, Evergrande's headquarters, have been urging state-linked property companies to buy Evergrande projects, but there's no indication that has happened at all. Instead, Evergrande has sold off stakes in companies that it part-owns.
In the last week, it has offloaded 5.7% of HengTen Networks Group (HK:0136), a subscription video-streaming service. That raised around HK$1.12 billion (US$144 million), near enough the amount due today. It also sold 11% of HengTen in August, causing a short-term boost in a stock that has nevertheless declined 23.8% so far this year.
Evergrande shares opened flat but shot up 3.5% at the close today, in apparent anticipation of the company making the necessary interest payment, and staving off default for a third time. But some analysts say it is only a matter of time before it does in fact default.
While regulators have been quick to play down Evergrande's importance, and to stress that its financial risks are limited, the "Evergrande effect" threatens to throw China's property market into a vicious spiral. Home prices fell in September in more than half China's 70-largest cities, and buyers have little confidence in the market, with more and more developers running into trouble. That is causing them to hold off on property purchases. That in turn robs developers of a key source of quick cash at a time their bonds are costing huge amounts of interest, and banks are restricting lending.
The root cause is Beijing's introduction in August 2020 of its "three red lines" policy, limiting how much developers are allowed to borrow. Developers have to maintain a liability to asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash to short-term debt ratio of more than 1x.
That has left the most-leveraged developers scrambling to meet requirements. Only 6.3% of Chinese developers could satisfy all three red lines at the time of their introduction, S&P calculated.
Since it is state policy that has created the liquidity issues for developers, Beijing could presumably tweak the measures if the entire property sector runs into trouble. For now, it appears happy to let some private developers struggle, even as it tells them to meet obligations to creditors.
But momentum is a powerful thing. Government policy the world over often remains in place too long, is hard to change at the flick of a switch, and also has unintended consequences. The failure or pulling of land auctions when no developer feels well-funded enough to bid is, for instance, robbing city and provincial governments of a key source of income.
As the debt-drunk developers stumble from default due date to due date, scrambling to raise the necessary funds, there are certainly some that will find themselves drinking their last drop at the Last Chance Saloon.