Asia Bi-Weekly: A Year of Two Halves (May 31 – June 14)

This has been written many times, but it bears repeating at the outset: What we are witnessing in China’s real estate and tech sectors is ultimately politically motivated, and unprecedented. Ultimate outcomes cannot be predicted with precision.

In December I wrote that if 2021 taught me anything, it was that I shouldn’t try to predict 2022. The rough idea of this op-ed was to try to establish if anything had changed, and whether on that basis I could ignore what I had learned in 2021 and try to make predictions. My working hypothesis was that nothing has changed.

What is clear though is that some things have changed, but the focus on China’s “Dynamic Zero Covid” strategy and its widespread lockdowns has largely overshadowed a loosening of regulatory policy towards the country’s real estate sector. But while that regulatory loosening is positive for the sector, the impact of mass lockdowns on China’s economy is very clear, and clearly negative for the sector.

It’s hard not to focus on the economy. I’m not sure anyone had on their China real estate bingo card at the start of 2022 that the Omicron variant would lead to months-long mass lockdowns of multiple Chinese cities, a slowing of the economy to early 2020 levels, unemployment hitting 6.1%, and Li Keqiang instructing 100,000 officials via the Internet in May to stabilize the economy “by any means necessary,” as the nation’s Zero Covid policy would remain in effect. Li effectively signaled that China’s targeted GDP growth rate of around 5.5% for 2022 might not be obtained.

Authorities have imposed full or partial lockdowns on dozens of Chinese cities, including the financial capital Shanghai, where a further full lockdown was put in place over the past weekend.

Set against that, China’s policy response to the slowing economy has signaled an intention to support the real estate sector, effectively recognizing its economic importance.

A rate cut in May from the People’s Bank of China to the five-year Loan Prime Rate for new home buyers, from 4.6% to 4.45%, followed an April collapse in mortgage lending, with new mortgages down RMB 60.5 billion ($8.95 billion) for the month, and came after Li Keqiang’s call for stabilization. The PBOC’s announcement noted, though, that the minimum mortgage rate for second home buyers was unchanged, with the country’s central bank reiterating that “housing is for living in, not speculation.”

Earlier in the year, various regional cities lowered down payment ratios for first-time buyers, along with providing support through subsidies.

More significantly, five real estate developers – Longfor Group, Country Garden Holdings, CIFI Holdings, Seazen Group and privately owned Midea Real Estate Holding – are now widely viewed by the market as “golden” or “chosen,” after a May 27 virtual roadshow hosted by the Shanghai Stock Exchange revealed they had been uniquely selected to issue new onshore bonds supported by credit protection instruments from underwriters, including credit default swaps and credit risk mitigation warrants.

Subsequent to that roadshow, Seazen also priced $100 million 7.95% 364-day senior notes due June 2023 at par, in a rare instance of a Chinese real estate developer accessing offshore high-yield markets this year. The notes, issued through New Metro Global, carry a parental guarantee from Seazen Group, and Reorg reported from sources that they were issued with support from the company chairman’s associates.
However, as we also reported, the issue of the USD notes – combined with a May 30 issue of RMB 1 billion ($150.1 million) 6.5% 2+1 year credit-enhanced MTNs due May 30, 2025 – can only be taken as an indication of strength, regardless of credit enhancements or support, as Seazen issued both a rare high-yield USD note and achieved onshore quota to issue.

Again, you can set this off.

While the PBOC’s May rate cut signaled that a freefall in China’s economy would not be tolerated, and acknowledged the critical role that real estate plays in the economy, developers still struggle with reduced contracted sales and a lack of access to funding. It will likely be months before easing measures have a material impact on the market.

And if the fate of the five “golden” real estate developers seems assured, sources see high beta names like Powerlong Real Estate Holdings and Agile Group Holdings as likely candidates to hit a refinancing wall within the next month or two.

One-off 364-day offshore issuances supported by friends and family, backed by an SBLC and/ or a corporate guarantee, do get the job done and certainly bode well for those that can. But they do not constitute a viable financial market, and sources of capital available to most developers are limited in the extreme.

China’s economic slowdown and regulatory drives mean only $2.1 billion has been raised through IPOs and secondary listings in Hong Kong, down from $20.7 billion over the same period the previous year, the slowest start to a year since 2013, Reuters reported in May. Capital markets and bank loans are unavailable to most developers. The investor base that provides capital offshore and onshore is significantly reduced and substantially altered, and many funds still see China as uninvestable for the moment.

S&P noted in a May report that offshore defaults for Chinese bonds in 2021 broke the prior 2020 record by 4.2 times in terms of amount, with a 3.3% default rate driven by unprecedented failures of property firms. The same report notes that 2022 will see even more bonds due at $103 billion, larger than both 2020 ($87 billion) and 2021 ($96 billion), and that the high default rate may continue.

One critical area to watch in the real estate sector in coming months is contracted sales. While sources argue these have bottomed out, the question now is whether they will rebound fast enough to adequately support the financial needs of high beta names.

Again, it comes back to the economy and whether we will see greater government stimulus in a bid to boost home buyer confidence in the second half. Similarly, questions remain over whether onshore and offshore capital markets will fully open or remain only partially open to select issuers.

It’s easy to argue that little visible progress has been made in offshore restructuring of Chinese real estate bonds in the first half of 2022, but regulatory loosening has been overshadowed by Covid lockdowns and the country’s economic slowdown.

The extent to which the economic slowdown could affect Chinese real estate developers and restructurings cannot be predicted.

Under such circumstances, predictions are best kept broad and vague.

So, to exploit a couple of sports commentator platitudes in order to make a prediction, the game is finely balanced and could go either way.

2022 may yet turn out to be a year of two halves.

–Stephen Aldred, Managing Editor – Asia

From Reorg Asia’s Managing Editors
In this column, managing editors Stephen Aldred and Shasha Dai take turns writing about trends in high yield, distressed debt, restructuring and bankruptcy in major Asian markets including China, Southeast Asia, India and Australia. Any opinions or other views expressed in this column are the author’s own and do not necessarily reflect the opinion or views of Reorg or its owners. To request trial access to Reorg for you and your team, click here.