Isn't the Chinese property bubble obvious?

Wed Jan 30, 2013 10:49pm EST

* Record number of bonds suggests overheating

* Developers taking additional loans as well

* Ability to repay debt being questioned

By Nachum Kaplan

Jan 31 (IFR) - Divergent views are emerging over whether there is a bubble building in the Chinese property sector, which has produced a string of aggressive high-yield issues this year, the most recent of which was Greentown China's conveniently successful US$400m bond this week.

The recent hot flow of money into Chinese high-yield property bonds, much of it from private banks unable to earn a decent return elsewhere, had the look and feel of a sector overheating, and many have indeed traded down in secondary.

If it looks like a bubble and inflates like a bubble, then it will ultimately pop like a bubble.

Not everyone thinks there is a bubble, however. Moody's certainly does not and has said in a report that the recent spate of bond issuance had actually shored up the sector's liquidity and generally extended many issuers' maturity profiles. Add in the sector's stronger than forecast sales growth, and the agency believes the Chinese property sector actually had an improved credit profile.

What lies behind the discordant views? Much of it hinges on whether one thinks it is a liquidity squeeze or a fundamental inability to repay debt that might get the sector into trouble. Borrowing money certainly gives a company more liquidity and can provide an easier repayment schedule.

That's what many Chinese property companies have been doing - refinancing short-term debt with longer-term facilities and on pretty cheap terms, too. That is smart and it certainly mitigates refinancing risk. Credit risk, however, is about more than just liquidity and refinancing risk. It is also about the fundamental ability to repay debt, and that is the shakier part of the equation.

China's property companies are not just taking advantage of low rates and abundant liquidity to refinance debt; they are aggressively taking on more debt in the form of loans. Outstanding loans to Chinese property companies rose 13% last year to Rmb12.11trn, while loans to developers (land and property) rose 11%, according to a report by Morgan Stanley.

It is axiomatic that the more money a company owes the harder it will be to repay, regardless of maturity profile.

Yes, one can take the view that Chinese property's robust sales growth justifies the extra debt property companies are assuming. That view is utopian. Such strong sales growth, especially in the face of the extensive measures the Chinese government has taken to cool the property sector, looks like strong evidence that the market is overheating - and vulnerable to a correction. When that happens, this debt the sector is assuming will suddenly look much less affordable.

Prices in the secondary bond market increasingly reflect this more negative view. While many of these property issuers may have amusing names, less funny is their performance in secondary. This year's deals for Agile Properties, Powerlong, Fosun International, Longfor and Future Land are all trading below par.

Optimists, however, might argue that the market has not really lost confidence in the sector and point to the success of the most recent Chinese property deal, Greentown's US$400m five-year non-call three bond. The deal was increased from US$300m and got away at 8.5%, well inside the 9% price talk, thanks to a US$2.8bn order book.

The success of Greentown's bond is illusory, however. Far from showing the market still has appetite for the property sector, it shows the exact opposite.

An unusually high 25% of the deal went to corporate investors rather than true bond investors. Premier Hong Kong corporate Wharf Holdings, which owns 24.6% of Greentown, was among the corporate buyers of the paper. It is not known how much of the corporate bid Wharf Holdings accounted for, but such actions hardly indicate confidence in the market.

The market is not always right, of course, but in this instance it would take a brave person to bet against it.