China may be set for rare property defaults, Neuberger says

Chinese developers may be headed for rare defaults on their debts as rising interest rates make it harder to roll over record borrowings, according to one of the few foreign money managers selling local financial products to the nation’s investors.

Smaller property firms might miss payments on bonds this year after the government’s leverage curbs pushed up borrowing costs, according to Neuberger Berman, which started its first onshore private fund this month for qualified investors, with a focus on fixed income. There haven’t yet been any defaults on publicly issued bonds from developers in China’s local market.

“Smaller developers don’t have sound cash flows and can’t tolerate any halt in refinancing because of their high leverage,” said Peter Ru, chief investment officer of China fixed income at Neuberger Berman Investment Management (Shanghai) Ltd., a unit of the New York-based firm. “Weaker developers may face even higher borrowing costs.”

Some local real estate companies have been forced to swallow record rates to raise money, and a government crackdown on shadow banking has cut a major cash lifeline for the weakest among them. The timing is bad as property firms face a record 110 billion yuan (USD17.52 billion) of onshore note maturities for the rest of this year. On top of that, investors also have options to sell 205 billion yuan of bonds back.

Real estate companies with total assets under 40 billion yuan and debt-to-asset ratios higher than 70 percent face high default risks this year as they don’t have enough sources to tap for refinancing, according to Ru at Neuberger Berman. The median total debt-to-asset ratio for 127 China-listed property developers was 31 percent as of Sept. 30, according to data compiled by Bloomberg.

The average coupon rate for local property bonds rose to 6.41 percent in the first quarter from 5.32 percent a year earlier, according to Bloomberg-compiled data. Tianjin Real Estate Trust Group Co., a developer based in the northeastern port city of Tianjin, issued five-year bonds with a yield of 9.5 percent in March. That was the highest coupon for the company and for real estate bonds with similar maturities, the data show.

In the offshore market, Guorui Properties Ltd. sold one-year dollar notes at 10.2 percent in the first quarter, a record for similar-maturity Chinese corporate bonds in the currency.

Neuberger Berman only buys bonds from developers in China that rank among the top 30 in terms of revenue, as such firms have a higher ratio of cash to maturing debt this year, according to Ru.

For onshore corporate bonds in general, Ru expects the government’s financial deleveraging will increase the number of defaults and prefers higher-graded securities, with local ratings AA+ or above. He said he’s the most concerned about credit risks of local government financing vehicle bonds. Bloomberg