China real estate asset sales prices imply high bond recovery Recent asset disposals by Agile and Shimao may give an indication of the discount levels at which future asset sales by distressed real estate firms might take place. Cost accounting for inventory understates value and may imply lower actual leverage. High recovery may drive a further rally in China's high-yield developer bonds.
Recent asset sales to support bond prices Recent sales from Shimao, Agile, and Vanke indicated where the disposal price would be for inventory, and sales of equity stakes will be relative to book value. All real estate inventory and equity stakes in JVs are accounted for at cost. Any valuation gains from the inception of the projects are not reflected in the balance sheet. Most inventory in real estate developers has a vintage of five years or less. Using the CRIC's data on Chinese residential housing, we can estimate the approximate gain in the valuation of the inventory. Based on the data, the 2.5 year gain for the average selling price of 50 cities is around 15%.
The asset sales so far have been above book value. This implies that the discount to the market is less than the rise in property prices. This will push up recovery price calculations for the bonds.
CRIS 50 cities three-year gain in ASP
Source: Bloomberg Intelligence
China real estate hidden leverage offset by hidden revaluation Hidden leverage via wealth management products remains an issue in China's real estate sector, but another factor may offset some of the concern. China's accounting methodology marks inventory at cost. Therefore, the current book value of the inventory reflects the cost of production and the land, not the selling price of the properties. Using historical price data, we can estimate how much the inventory is worth, which will allow us to calculate the adjusted leverage level. At the same time, the adjusted valuation and the level of asset sale discount will allow us to estimate the recoveries better.
Based on current asset sales from Agile and Shimao, it appears that the discount level remains lower than the price gains over the last few years. This may provide some comfort to bondholders on recovery values.
Estimated asset sale discount
Recovery valuation imply rally for China RE bonds may continue Accounting standards for developmental assets at cost together with the historical rise in real estate prices imply for most, if not all of the issuers, that bond recovery levels are higher than current market levels. This implies a significant upside for China HY property bonds. The recent profitable asset sales by property firms have set a benchmark which we can calculate the recovery levels for bondholders in the event of liquidation. A conservative estimate of a small discount to book value (or 25% discount to market value) will lead to high recoveries. In the case of Evergrande, the latest equity to asset ratio is around 21%. As as long as asset sales occur at less than a 20% discount to book value, recovery will be full, assuming the leverage ratio is accurate.
The HY bond market may rise significantly to reflect this
Bloomberg China HY Index (I29381US Index)
