Chinese property developer Kaisa Group Holdings missed a coupon payment of $23 million on its 2020 bond in early January. The reaction of some foreign bondholders to the news (once the company finally confirmed the default a week later) was like someone suddenly woken from a deep slumber, as they realized the realities of holding Chinese corporate debt. Namely, that you have no real recourse to onshore assets and will be treated like an unwanted stepchild by the authorities when it comes to recoveries, with domestic creditors always taking priority.
You have to wonder if investors paid any attention to previous experiences such as Suntech Power, which defaulted in 2013. Thus far, US bondholders in Suntech have received nothing versus the 30 cents on the dollar recovered by domestic creditors.
A highly experienced Asian insolvency lawyer described to me at the time, with incredulity, how a group of US-based fund managers glibly expected to sue Suntech in the Chinese courts, and win. The mind boggles at the assumptions made by these valiant guardians of other people’s money.
This year, three factors are a given in Chinese real estate debt; Chinese economic growth is slowing, second, with this slowdown the Chinese property market can no longer continue to defy gravity like some Looney Tunes cartoon and lastly, holders of US dollar bonds issued by Chinese developers are going to discover some hard truths.
Some will argue that Kaisa’s woes stem from specific issues with the sale of some Shenzen properties. That may be, but the company is the proverbial canary in the coal-mine. These woes are not specific, but systemic.
Sure, right now, there is a relative value trade in property-related bonds, all supported by the brokers who have never seen churn that they dislike.
However, for all the supposed strengths or weaknesses of the various property companies underlying this trading, many of these companies will struggle to make payments on medium term paper.
The good news is that this means investment opportunities for private debt investors. As public securities holders get mauled and Chinese and foreign bank lenders face increasingly stressed loan books, private debt funds will be able to move into the inevitable void.
This is where true relative value analysis is going to be crucial, assessing which developers and which assets you want to bet on.
The best plays will be investments in specific property assets which are undervalued by creditors at the corporate level. Finding these gems and accessing them through primary lending or purchasing development loans at a discount via secondary trading looks ideal but finding such granular investments will be difficult and will require a significant presence in China.
Capital controls are, as ever, an issue, but structures exist and have been used to give true debt-like protections.
For those private debt investors lacking a wide local network on the mainland, there are two routes for accessing lending opportunities to the ‘right’ developers. First of all, it’s possible to team up with a local fund with the right presence, if not expertise. Some of the local private equity funds will be looking to raise debt funds. It’s also possible to open managed accounts with the more regional special situations funds that have been successfully investing in China since before 2008.
Of course, there is also a wider Asia-ex Japan play opening to private debt investors, driven by cases such as Kaisa. Junk bond issuance in the region has ground to a halt as investors suddenly remember all that trifling stuff around collateral and repayment that was forgotten again in the hubris of the last few years – as if the 2008 meltdown never happened.
So there are a host of smaller, riskier corporates in Asia seeking alternative debt financing. This spells happy hunting grounds for the cannier investor in the medium term.
The only people I see gaining in the short-term, however, from the slow motion train crash in Chinese property debt are the restructuring experts such as Houlihan Lokey, which was recently appointed as financial advisor to Kaisa to help it regain a sound footing.
I would wish the folks at Houlihan luck, but they don’t need it, there’s going to be a lot of work coming their way this year and well into 2016.