Warning of “vicious cycle” in Chinese real estate sector

Investors should expect more Chinese real estate defaults in 2022 – that’s the view of one of the most respected specialist Asian investment firms in the United States.

Amid the well publicised China Evergrande debt crisis, a series of other Chinese real estate defaults have occurred in the later stages of 2021 and into 2022.

The following have officially confirmed default or been downgraded to a default status by leading credit ratings agencies:

  • China Properties Group: Announced in October 2021 it had defaulted on a note worth US$226 million.
  • Modern Land: Announced in October 2021 it had defaulted on principal and interest on a US$250 million bond.
  • Fantasia Holdings: Also in October 2021, a surprise announcement revealed it had defaulted on US$206 million note.
  • China Fortune Land Development: Disclosed US$1.2 billion in new debt defaults in November.
  • Kaisa Group Holdings: Confirmed in December 2021 that it had defaulted on principal and interest payments on a US$400 million note.
  • Guangzhou R&F Properties: Downgraded to “restricted default” status by Fitch in January 2022 after delaying a $725 million senior unsecured note payment.
  • China Aoyuan Group: Announced in January it had failed to make coupon payments on US$1.09 billion worth of notes.

Teresa Kong, Portfolio Manager at Matthews Asia, says she believes it will most likely be smaller Chinese property developers to next lay bare their untennable debt woes.

“In our view, smaller developers that are over leveraged are at highest risk of default this year. We would also expect to see more debt extension and distressed debt exchange to happen this year,” said Ms Kong.

“While the total defaulted may not exceed last year’s US$44.7 billion, we may see more smaller developers defaulting.”

“Vicious cycle”

Ms Kong also warns the contagion effect from Chinese real estate defaults may cause a “vicious cycle” which could impact even well-managed Chinese property developers in 2022.

“From the perspective of international bondholders, the single biggest risk is the inability of high-yield property developers to borrow in the U.S. dollar (USD) bond markets. Many Chinese developers have strong operations and management teams but can’t issue new bonds because market participants are not discriminating and are demanding a high credit premium.

“This means that their bonds are trading at 50, 60 or 70 cents on the dollar with high implied probabilities of default.

“The contagion from other defaulted developers may cause a vicious cycle which could be self-fulfilling unless market sentiment turns around.”

How sentiment could turn in the Chinese real estate sector

Kong points to three factors that could have a material impact on sentiment:

  • More targeted Government policies to open property funding channels.
  • Increasing merger and acquisition activity.
  • Willingness of property developers to issue equity, even at depressed valuations.

Kong says while the situation has improved in recent months there have “not been sufficient improvements for a broad restoration of confidence”.

Related: Evergrande downgrade forces BlackRock and other institutions to write-off billions