About 70% of China's high-yield real-estate bonds have become uninvestable for funds with strict mandates such as traditional long-only asset managers, as issuers either default or seek bond exchanges. China's zero-Covid policy could boost the ratio by causing urban lockdowns that further weaken developers' sales in 2022, sapping their liquidity.
China defaults may push junk-bond exchanges toward perpetuals The refinancing needs of investment-grade developers are nominal for the rest of 2022, amounting to less than $3 billion at five firms. Investment-grade developers are mostly owned by SOEs and have better access to onshore funding and bank loans, with the exception of Country Garden. Non-state-owned Country Garden will have higher refinancing needs and account for 28% of the total, or around $700 million. The peak quarter for maturity will be in July, with more than $1.1 billion of bonds coming due. The investment grade category only has bonds maturing in April, July and November.
Issuers, bondholders may face prisoner's dilemma Bond issuers and holders may face a "prisoner's dilemma" in which each side chooses to protect itself at the expense of the other, ending up worse off than if they'd cooperated. In at least one Chinese real-estate bond exchange -- Redco -- the minority of holders who rejected the exchanges ended up having their non-exchanged bonds (stubs) paid in full. This creates an incentive to hold out against exchanges -- but if too many holders do so and an exchange is rejected, the firm may have to liquidate with all investors suffering. Some developers -- Yuzhou, Dafa -- have chosen not to pay holdouts and used votes on exchange offers to strip bonds of covenants protecting them. This can put holdouts in a difficult position as brokers tend not to provide liquidity to them or make markets in relatively small amounts of stubs.
A successful exchange (stub repaid)
Source: Bloomberg Intelligence
Post-exchange defaults increasingly common A completed exchange doesn't necessarily mark the end of a company's troubles. Holders of exchanged bonds may be asked to extend them for a second time in 1H23 if China's property market recovers more slowly than expected, partly because of COVID lockdowns in big cities. Post-exchange defaults may become increasingly common as distressed exchanges inflict reputational damage on companies, potentially prompting bank lending to tighten, which could cause issuers to miss even interest payments.
Zhenro, Yuzhou, Yango and Dafa have all missed interest payments soon after completing exchange offers. This suggests full-scale restructuring of the companies might become unavoidable if the property market doesn't start recovering in 2022.
Post-exchange defaulted developers
Result delays, auditors' exodus blur developers' cash reality Inconsistent disclosure on liquidity, especially on restricted cash such as amounts held in escrow, is making it even harder for investors to take decisions on proposed bond exchanges. One deadline for the market is end-April, by which time developers are required to issue audited results for 2021; if they don't, bond covenants related to financial reporting could be breached.
By April 26, 30% of developers hadn't reported audited 2021 results, while six had changed auditors and the shares of companies including Evergrande, Fantasia, Sunac, Modern Land, Kaisa and Sinic had been suspended from trading for failure to issue unaudited annual results by end-March.
Auditors change, results, going concerns
