Views on China | Hong Kong’s a lush country garden for China developers

Getting tired of high-yield dollar bonds? Don’t worry, China’s innovative real estate developers can always find a way to tempt you.

Profit margins in the market for dollar debt are thinning as a huge local savings pool pushes down yield premiums to almost their lowest level since 2009. Meanwhile, the Federal Reserve is dominating headlines again, with a March rate hike looking all but certain (traders are betting on a 93 percent probability).

Against that background, China Evergrande Group managed Wednesday to sell a HKD18 billion (USD2.3 billion) five-year convertible bond. Granted, the developer had to revise its aggressive terms – it had wanted to issue a perpetual, with the option of deferring coupon payments – but this is nonetheless an achievement for a high-yield real estate company with an estimated 162 percent net debt-to-equity ratio.

Take a look at the terms and you know this is another win for Evergrande. The coupon is just 4.25 percent, by far the lowest among its bonds. The conversion price of HKD38.99 is a 40 percent premium to Evergrande’s close before the deal – but the shares have already run up by close to 380 percent in the past year, so perhaps there is not much upside left?

The secret sauce is the Hong Kong dollar, which is pegged to the U.S. currency. Evergrande’s previous issues were in greenbacks or yuan.

Not coincidentally, two other high-yield developers tapped into the Hong Kong dollar bond pool this year. Country Garden Holdings Co. issued HK$15.6 billion of debt Jan. 16, and CIFI Holdings Group Co. came in a week later with HK$2.8 billion. Both are convertibles with zero percent coupons. As I’ve written, the two companies now deserve investment-grade ratings, at least according to the Bloomberg risk calculator.

Before 2015, the Hong Kong dollar bond market was vibrant, with issuers ranging from Tencent Holdings Ltd. to Kingsoft Corp. Investors in China piled in, because the bonds counted toward a HKD10 million investment that opened the door to permanent residence in the city. Then the Hong Kong government suspended the Capital Investment Entrant Scheme, and the local-currency market became a boring place dominated by sovereigns and China’s big banks.

The developers’ entry this year is bringing the market back to life. Evergrande and Country Garden are the second- and third-largest issuers, behind the Chinese government and ahead of Bank of China Ltd.

And they’re clever, tapping into an unsung cousin’s thirst for yield and growth. A preliminary search by Gadfly suggests there are at least a dozen funds with more than HKD26 billion of assets under management that track only Hong Kong dollar-denominated bonds.

The HKD17 billion Shroder International Selection Fund, for example, is full of stodgy Hong Kong government debt. The fund, whose aim is capital growth and income, might like some convertibles from China’s top-tier developers, which grossed more than 500 billion yuan (almost $80 billion) in sales last year. The well-regarded $5.2 billion Value Partners Greater China High Yield Income Fund, which loves China real estate developers, has 2.1 percent of its money in Hong Kong dollar bonds. (Evergrande’s two dollar bonds are already in the fund’s top 10 holdings.)

China’s big developers know a good thing when they see it in Hong Kong. They’re the early birds tapping pent-up demand, giving them less reason to fear the Fed. Shuli Ren, Bloomberg