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$10 Billion Property Bond Defaults Are Just Around the Corner
Chinese local governments are tightening their oversight of developers’ pre-sales process.
www.bloomberg.com
Shuli Ren
You would think the worst credit events in China’s modern corporate history are behind us. In late 2022, the government vowed to stabilize the housing market, and reopened the economy after three years of harsh pandemic restrictions.
Despite these tailwinds, defaults are back. On May 14, Guangzhou-based KWG Group Holdings Ltd., one of the few developers that obtained a state guarantee for its latest yuan note issue, said it had failed to make a $119 million redemption payment, thus triggering a cross-default of all its $4 billion dollar bonds. Meanwhile, notes issued by Powerlong Real Estate Holdings Ltd. have plunged in recent days, as traders see little chance of the Shanghai-based builder repaying a $15.9 million coupon due later this month.
The high-yield property dollar bond market will witness another $10.1 billion of defaults this year, after a record $63.7 billion in 2022, according to estimates from HSBC Holdings Plc. The bank also sees credit risks lingering for China SCE Group Holdings Ltd. and Central China Real Estate Ltd.
Mission Accomplished?
High-yield developer dollar bonds are expected to incur a 22% default rate this yearSource: HSBC
So why are developers reneging on their debt obligations again?
Late last year, amid homeowner protests against stalled construction projects and threats of mortgage boycotts, Beijing raced to ensure that builders could deliver pre-sold flats to disgruntled buyers. All bureaucratic resources were deployed: State-owned banks quickened developer loan approvals and municipalities launched rescue funds.
China may well consider its mission accomplished. Real estate projects are being completed again, and home prices have risen for three consecutive months.
But local governments have also learned a lesson. They now have political incentives to tighten the scrutiny on the pre-sales process. To them, consumer protection — and therefore social stability — is a lot more important than whether developers can repay their dollar bonds or not.
Funding Stress
New worries are emerging that local governments are tightening scrutiny over pre-sales cash escrow accounts again.Source: National Bureau of Statistics, Bloomberg
KWG certainly blames its non-payment on that. Due to “the requirement of local government policies,” most of its money is “under strict pre-sale cash escrow at designated bank accounts in order to ensure completion of the properties under development.” Therefore, despite its best efforts, the developer’s funds for offshore debt payments are facing “continuous pressure,” the company said in a recent filing.
Pre-sales, where apartments are bought before they are built, is the predominant business model in China’s real estate market. Once a contract is signed, a homebuyer’s down payment and mortgage proceeds from the bank are wired into an escrow account. In theory, a developer can access that money only as construction progresses. But some builders had siphoned the deposits away for other purposes, resulting in stalled projects and angry consumers. As such, municipalities now want more say in how these funds are being used.
Cutting off developers’ access to escrow accounts inevitably sends many into distress. Last year, consumer deposits and advanced payments accounted for about one-third of builders’ funding, while bank loans took up only around 12%. Tightening at the local government level would deal a fatal blow to already vulnerable builders.
So brace yourself: Developers’ woes are not over. With the economic outlook so uncertain, whether privately owned builders can survive rests ultimately on the strength of government support. Right now, their interests are not aligned with the state’s.
