Bond Focus: Insight into the Role of Rollover Through KWG’s Default

Looking at the results, aside from 11 developers, including Greenland and China South City, the remaining developers defaulted within the extension period. Their bond price now traded at less than $20, and some of them even in single digits.

For the "surviving" developers, there is still the following information worthy of investors' attention:

1.       Greenland, China South City, and Central China have SOE backgrounds, which could bolster their fundraising capability. In other words, non-SOE developers could be less likely to get support from the capital market. Secondly, Greenland and South China Town are both in their second-time extension. Since the new maturities are concentrated in 2024 and 2025, leaving the companies less pressure from debt repayment now. But we could not rule out the possibility of default moving forward. Moreover, the reason why Central China does not default is that the company just completed rollover recently, but the likelihood of actual default is very high given the low market price.

2.       Among the remaining non-defaulted property developers, except for Powerlong and Guangzhou R&F, the rest of them are small-sized with one to two USD bonds outstanding, making them easier to manage the debt repayment schedule and raise funds. Furthermore, a more favorable situation for these small-sized developers is that the bondholders may also be major shareholders or stakeholders of the companies, resulting in a smoother process of extension, even with 100% acceptance for some exchange offers, like GD-HK GBA Holdings. Not only that, they are also pretty easier to get second-time rollovers, such as Huijing Holding and JY Grandmark.

The above results clearly illustrated that rollover is not as useful as expected, and the majority of developers could not avoid the fate of default. For the non-defaulted developers, they either are small-sized, with limited reference for their rollovers, or the extended bonds are yet to mature, and actual default is very likely. From the point of view of market price, only China South City could be able to trade at over $70, reflecting a probability of being out of distress.

Why is Rollover Ineffective for Chinese Property Developers?

As a widely-used approach for the offshore bond market, rollovers have ever assisted a large number of issuers to step out of distress, even including some Chinese issuers like Shanshui Cement Group. So why is it ineffective for Chinese property developers?

The rollover does not entail a principal haircut but is essentially a way to postpone payments and pin hope for future liquidity improvement. Therefore, the key factors to emerge from the dilemma lies in the improvement in sale and refinancing. Unfortunately, neither of these two factors showed significant improvement in the current environment.

In terms of sales, the market sentiment is seeing a rebound with the support of loose policies. Data from the National Bureau of Statistics demonstrates that the aggregated sale of commercialized properties for the first four months of 2023 rose by 8.8% from a year ago. But it is important to point out that the sales recovery is not equivalent to cash inflow to developers owing to the restriction of pre-sale proceeds, as developers are required to deposit pre-sale funds to a designated account, which can only be used for project construction. Although the "16 Measures" announced last year allow developers to withdraw pre-sale proceed earlier by a bank letter of guarantee, no substantive progress has been observed. In addition, based on our previous experience, about 40% of pre-sale proceeds are released until the completion of the project, which is about 1-2 years later after the construction begins. In a word, the developer's liquidity would improve after 1-2 years of improved sales.

Looking into refinancing, according to the data from CRIC, the total refinancing amount of the Top 100 developers plunged by 42% YoY in 2022, the lowest ever since 2016. Even with the easing policies such as " 16 Measures" and "Third Arrows" at the end of last year, the capital market is still very cautious about refinancing for developers due to the consideration of credit risk management. As a result, only SOE developers or some non-SOE developers without credit risk exposure could be able to get refinancing. This is why Greenland and China South City, which have SOE backgrounds, can make payments as scheduled, but the remaining rolled-over developers eventually ended up in actual default.

All in all, it is less likely that the developers’ liquidity could significantly improve under the current situation, and rollover plays a role in serving to postpone an actual default. On the other hand, rollover provides some relief to developers, ensuring that they can continue to operate normally to think about the next step in solving their debt problems.

Rollover Is Treating the Symptoms but Not the Underlying Disease, Developers Shift to Debt Restructuring

Prior to the first half of 2022, the rollover was still quite unfamiliar to Chinese property developers. in terms of length of the rollover, most cases were 6 to 12 months, which led some developers to have second-time rollovers because of the inability to pay. In the meanwhile, the shorter length of the rollover may result in more concentrated maturities, challenging the developer's fundraising. We thus note that some developers' rollover turned rational since the second half of 2022. Taking Guangzhou R&F as an example (Table 2), the company uplifted the length of the rollover to 3-4 years, with credit enchantments embedded.  In addition, the rollover plan will not simply extend the maturity date, but will also involve various terms such as coupon rate reduction, in-kind payment, and installment payment, which are somewhat similar to the debt restructuring approach.

Table 2: Onshore and Offshore Bond Solutions 

 Objectively speaking, based on the rather poor sale of property and enormous debt amount, it is impossible to solve the debt problem by relying on its own operation, and the rollover is treating the symptoms but not the underlying disease.  A growing number of developers favor debt restructuring to get rid of distress, including Evergrande, Sunac, and Fantasia. We believe that an extremely low recovery rate has been gradually priced in by onshore bondholders, who no longer expect to get all the principal back. For developers that are yet to default, they might give priority to debt restructuring, instead of the rollover, in case of debt payment inability.

Therefore, rollover is ineffective for Chinese property developers under the situation where the defaulted developers' liquidity is not materially improved and postpones the actual default.  Few developers could get out of distress through a rollover. The offshore bond market is losing patience with rollovers and tilting to debt restructuring.