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Developers high-yielding bonds may carry sting

HONG KONG: The good news first: people who invested in bonds issued by newly listed China developers are getting record high interest rates. But the bad news is that the risk of losses on these bonds is mounting as the housing market shows signs of slowing.

Last Friday, Fujian-based Powerlong Real Estate Holdings became the latest China developer to launch a US$250 million (RM779 million) bond, paying investors a 13.75% annual coupon over five years. The developer said the proceeds from the bond would be used to fund new and existing property projects.

Hong Kong-listed China developers are regular offshore bond issuers, constituting half of the size of the Asian high yield bond market.

In the past two months, a total of US$1.3 billion was raised from bond issues by mainland developers Renhe Commercial Holdings, KWG Property Holding, Shimao Property Holdings and Powerlong, paying investors annual coupons ranging from 9.65 to 13.75%.

Property sales took a hit in May after the government acted to curb speculation in the sector. Land supply for housing construction rose and banks were told to cut back on lending, making it harder for individuals to get mortgages for second homes.

Credit analysts said that prices of China property bonds plunged in May, especially the newly listed property developers, although many have since rebounded from their lows to par or above par in recent weeks.

Another newly listed developer, Shanghai-based Glorious Property Holdings, had to call off the launch of a bond in April because the high-yield bond market was too volatile as a result of the government's cooling measures, according to chief executive Cheng Lixiong.

Bond investors demanded higher interest from newly listed developers due to their low rankings and short track records, said Bei Fu, an analyst at Standard & Poor's.

It might take years for these developers to establish relations with banks, which are less inclined to lend to companies that are highly geared and offshore bonds offers a good funding channel for these firms, but they have to be prepared to pay a high price.

Although Glorious Property was not willing to pay the high price that bond investors demanded, Shenzhen-based Kaisa Group Holdings and Fantasia Holdings wanted to cash in on investors' interest before funding costs soared to a level that they could not afford.

Fantasia's US$120 million five-year bond in May pays an annual coupon of 14%, while Kaisa's US$350 million five-year bond in April offers 13.5%.

Fantasia chairman Pan Jun admitted that the company had paid a high price to borrow.

"But our net profits will not fall if we use the money raised to buy cheaper land sites," he said in May, adding that Fantasia had probably got on the "last train" to tap the international bond market with credit  becoming tight.

Many newly listed developers such as Evergrande Real Estate Group and Kaisa Group had borrowed heavily before their flotations, and chose to repay a portion of their debt using just a small proportion of the net proceeds, while allocating the remaining to fund land acquisitions, construction and projects. Following listings, these developers have chosen to use proceeds of these bonds to partially fund debt payments.

Fu at Standard & Poor's said China property developers tended to be more aggressive after gaining a Hong Kong listing, launching bonds to fund projects and land  acquisitions, hence they may overlook risk management in favour of expansion.

Both Moody's Investors Service and Standard & Poor's said they had no plans to downgrade any developers or their bonds that they had rated over the last few months.

Although property sales have since recovered from May's slump, for bond investors, the outlook is not rosy, especially if they have holdings in the bonds issued newly listed China property firms.

There are strong signs that the China property market has started to cool down. China's property prices rose at the slowest pace in eight months in August from a year ago, according to Vince Chan, a credit strategist at Amias Berman & Co.

Property values in 70 major cities climbed 9.3% year on year - less than the 10.3% year-on-year gain in July, Chan said.

CCBI Research said that an uncertain policy outlook remained the key risk for China developers, which are expected to launch more projects at discounts of between 10% and 20% in order to boost sales.

While Powerlong's bond made a promising debut on Friday and had been trading above par, Kaisa's bond fell below par yesterday.

China property bonds with weaker fundamentals such as Kaisa are much more vulnerable to macroeconomic and policy risks than their stronger peers, according to Chan.

And China property bonds track their issuers' listed shares closely. Shares of Kaisa, Powerlong and Fantasia have been trading below their respective offer prices since their listings last year.

The weak macroeconomic conditions together with a slowdown in sales has prompted fears that weakness in the property market will trigger bond investors to sell off their holdings in lower quality bonds such as those issued by the newly listed property developers.

"There is policy tightening risk in the fourth quarter, which together with bonds trading at historical highs, could lead to some corrections in bond prices," said Keith Chan, a corporate credit analyst at HSBC.
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