GLOBAL INVESTORS are all too aware of the discount to mainland business valuations due to Xi Jinping’s goal of reducing debt, property prices and inequality in China. For their part, borrowers have to expect a “Xi premium” on urgently needed capital. The Chinese leader’s policies may have created a dangerous credit crunch for many companies, particularly property developers, in global markets.
Regulators have shaken the foundations of China’s real estate market by increasing the amount of leverage that developers can take on. This has brought Evergrande, a home builder with more than 1,000 projects across China and $ 300 billion in debt, to collapse. She missed five payments on offshore dollar bonds in the past month. Several competitors have followed suit. Fantasia went bankrupt on offshore bonds on October 4th. Sinic Holdings said on Oct. 11 that it would likely default soon. Modern Land and Xinyuan Real Estate hope to delay payments on offshore bonds.
This wave of hardship has created a crisis in the offshore junk bond market. The spreads (ie the returns compared to the risk-free rate) have reached almost 17 percentage points, the largest difference in history. The market has largely closed to developers looking to refinance their debt in October, says Sandra Chow of CreditSights, a research firm. An investment manager for a global institution says that even non-real estate companies are being priced, noting that “that is the definition of contagion”.
The problems go much deeper than the string of missed payments. One fear is that Chinese authorities are pushing companies to ignore the interests of creditors and sell offshore assets and scoop home cash to ensure unfinished properties that have already been sold to Chinese are completed. The leading theory among investors is that Evergrande is buying time to prevent its offshore assets from being frozen by offshore creditors. On September 22nd, a “privately negotiated” resolution on a yuan bond was announced to prevent an immediate mutual default on dollar bonds. Though the group has since missed payments on dollar bonds, the group gives a 30-day grace period through October 23 before being deemed to be in default and creditors can seize their offshore assets. In the meantime, she’s selling everything she can, including a large stake in her real estate services unit and Hong Kong offices.
Other groups may consider a similar strategy. For the past few weeks, developers like Fantasia and Sinic have been reluctant to pay offshore coupons. Some cases have surprised investors, suggesting companies may be able to make these payments but are unwilling, says Arthur Lau of PineBridge, a Hong Kong-based investment manager.
If such behavior is tolerated or even encouraged by the authorities, it could have a devastating impact on the market for US dollar bonds from Chinese companies valued at $ 1 trillion. If yields stay high, there could be further defaults. After breaking up many private conglomerates looking to buy foreign assets and obstructing the sale of Chinese stocks in New York, Mr. Xi could now make his mark on the offshore bond market. ■
This article appeared in the Finance & Economics section of the print edition under the heading “Xi’s premium”