THE apparent default of leading property developer Kaisa Group Holdings Ltd shows clearly just how badly global investors are at pricing China risks.
Shenzen-based Kaisa said on Monday it had missed interest payments to investors in its offshore dollar bonds, that many of its bank accounts had been frozen and that a mainland China court had frozen more than US$100 million (RM358 million) of assets of one of its units.
Kaisa founder and chairman left the company in December, triggering an acceleration of repayment of a loan made by HSBC, which the company first missed but was then granted a temporary waiver.
Kaisa chief financial officer has since left.
The company, which had been well regarded, began its dizzying descent late last year, when officials in Shenzen began to block sales at its properties, as well as routine applications for licences and permits. This raises the possibility that the roots of its woes are at least in part political.
Kaisa’s actual condition is obscure, as are the underlying causes, but while all signs point to a very poor outcome for its investors and creditors, many of the risks were easy to see in advance.
Global investors, eager to make large returns and cash in on China’s stunning but now rapidly slowing growth, have made a habit of, if not ignoring these risks, then not extracting enough compensation for carrying them.
Three kinds of risk are embodied by Kaisa: political risk, playing field risk and China property market risk, all related and mutually amplifying and presented in descending order of importance.
It must be stressed that we simply don’t know why Shenzen officials suddenly took against Kaisa. They may simply have been doing their job.
All companies everywhere bear regulatory and political risks, but for those in a one-party state like China the risks are higher, and the potential exists that their ability to do business and profit is extinguished rather than impaired by official measures.
This is particularly true for property development, which is a key source of revenue for local and regional governments in China.
All of this obviously cuts both ways. Many property companies have done extremely well courtesy of kind treatment from local authorities. All companies in China are creatures of the state to a greater extent than they would be in the United States, Germany or Brazil.
Internet retailer Alibaba, for example, has been a beneficiary of politically motivated tight control of China’s Internet sector, which in part has allowed it to build massive market share.
Then there are the risks implied by the uneven playing field given to offshore investors in China, a situation well known but only rarely tested. While Chinese bankruptcy and reorganisation practices and law have not been fully tested, there have been clear precedents giving senior status to onshore, mainland creditors over those who buy offshore bonds or securities.
That’s especially true if the loans were made to offshore entities often set up for that purpose, rather than directly to the mainland company with assets.
That leaves Kaisa bondholders facing the strong possibility that they will be very far back in the line of hopeful creditors, with their claims given less shrift than those of mainland creditors, shareholders and even employees.
The Chinese legal system also has a history of prioritising local employment and economic issues over the claims of offshore creditors.
And then there is China property market risk. The country has been in a massive real estate bubble, with two to three years of unsold supply in many major cities. An 80% homeownership rate, against 65% in the US, implies limited un-met demand.
“The government is worried about a real estate bubble and the growing resentment towards sky-rocketing house prices, especially for those living in municipal cities.
The average young couple in Shanghai must work for 24 years, without spending a single yuan, to save enough money to buy a moderate flat,” Yu Yongding, economist and former member of the monetary policy committee at the People’s Bank of China, wrote at the end of December.
For at least a decade, growth in China has leaned totteringly on investment, particularly in real estate. That appears to be ending. House prices are down 3.7% in the year to October, and new home sales fell in 68 of 70 cities.
As we saw in the US, even small falls in house prices can be self-fulfilling in an overbuilt market, and while government control over credit may potentially remove some of the downside risk, we should expect to see more developers in distress if this trend continues.
Foreign investors shouldn’t claim they didn’t see the warning signs, or that they themselves did not have it coming. — Reuters
James Saft is a Reuters columnist. The opinions expressed are his own.
This article first appeared in The Edge Financial Daily, on January 15, 2015.