New World Development - Navigating Through Its Darkest Hour?

This Series of Bad News is Akin to being Besieged on All Sides

After the resignation of former CEO Eric Ma Siu-cheung from New World Development ("NWD"), more negative news and rumors are circulating in the market, including the following key points (except for the Group's official response, all information is unverified by the Group, and there are different versions of the news / rumors):

• Seeking loan waivers and extensions from banks:
• NWD had sent a letter to bank lenders requesting net debt to equity ratio to be increased to 100% from current covenant threshold of 80%, and asked lenders to suspend testing of net gearing ratio through the end 2025. The Group cited RMB depreciation as main reason for expected covenant breach. NWD has offered to pay lenders a consent fee and set 23 Dec 2024 as a deadline for banks to give consents. HKMA has guided banks to provide their approvals by Christmas. (Source: Debtwire)
• NWD is negotiating with lenders to extend maturity dates on some bilateral loans (undisclosed amount and extension period) (Source: Bloomberg)

• NWD is rumored to be considering an 8 measures to raise funds, including rights issue underwritten by Chow Tai Fook Enterprises (CTFE) and appointment of financial advisers and large debt haircuts. Some of the measures have already been denied by the bank lenders (Source: Mingpao).
• The Group's management had previously reiterated its focus on debt reduction in the future, exploring asset sales, stating no intention to redeem perpetual bonds, and no delay in paying perpetual bond interest (source: Hong Kong Economic Journal).
• Company-issued press release: “We have noticed a number of untrue speculations and rumours about the company have been circulating on the internet. We would like to reiterate that we continue to comply with disclosure requirements and provide timely and appropriate updates to our investors and shareholders. We will continue to focus on implementing our existing corporate strategy.”

This series of bad news is akin to being besieged on all sides, coupled with the NWD's response not explicitly denying the rumors, leading to the Group experiencing another round of stock and bond pledges. The bond prices fell even more than during the period of the rumoured “the hidden debt” in August last year. Currently, the Group's bonds fell by approximately 18% to 30%, with perpetual bonds experiencing the largest decline. The yield to maturity of the bonds or current yield of perpetual bonds is up to 20% to 25%.

Bank Lenders are likely to Approve Clause Amendment and Loan Extensions

We believe that some rumors are somewhat true, especially regarding the amendment of the net debt to equity ratio threshold and seeking an extension of bank loans. As at the end of June 2024, NWD's net gearing ratio (treating perpetual bonds as debt) was already at a relatively high level of 87%, and the Group indeed needs to refinance some of its existing bank loans.

NWD is currently facing certain financial pressures, and seeking amendment from banks on loan terms seems like a reasonable move. This should not deal a fatal blow to the Group and does not imply that the group will default on its debts in the short term.

NWD's unsecured loans amount to about HKD 92.9 billion, accounting for approximately 48% of its total debt. Additionally, bank loans totaling HKD 25.6 billion are due within a year and are yet to be refinanced. Whether banks are willing to approve these amendment and loan extensions will be the key factor determining whether the group will default in the short term. We believe that bank lenders are likely to approve them and assist the Group in overcoming the short-term difficulties, because:

• Bank lenders have a direct exposure of about HKD 130 billion in loans to NWD, with each bank carrying an average exposure of close to HKD 6 billion, even when the loan amounts are shared among around 20 banks.
• In the event of the NWD’s debt defaults, the banks have limited advantages during debt restructuring. Most of the bank loans are unsecured, and the repayment priority of bank loans is likely to be similar to that of offshore bondholders.
• The Group have valuable assets available for sale (Total property assets: HKD 350 billion). Given time to sell these assets at reasonable prices, the group still has a certain debt repayment ability.

Therefore, we believe that NWD is not likely to default on its debts in the short term, and the rumors of significant debt haircuts or restructuring should consider incorrect.

However, it is important to understand that the real estate industry has a high degree of reflexivity. Following the spread of negative news about NWD, it is likely to impact its property sales, asset disposal plans and additional financing ability, leading to a vicious cycle that could indeed increase the default risk going forward.

NWD has High Chance of Overcoming this Challenge and Repaying Debts on time

We need to emphasize that the focus of bond investors should be on whether the Group still has the ability to repay debts on time (both principal and interest). The factors like the profitability, credit metrics or rumors are just some factors in analyzing its debt repayment ability. Currently, we believe the 3 key factors are as follows:

• whether the bank loans due in the short-term can be extended or refinanced (around HKD 25.6 billion remaining for the FY25 and around HK$30.8 billion for FY26),
• whether the contract sales in Mainland China can maintain a total of around RMB 4 billion per semi-annual, and
• that the Group should roughly reach the annual non-core asset disposal target of HKD 13 billion without deviating too far.

If these data roughly meet expectations, the Group is expected to get through the toughest phase of the next two years, meaning that they should be able to pay expenses, interest and ongoing bond principal on time, giving the Group more time to sell more property assets at reasonable prices.

We believe that NWD has a high chance of overcoming this challenge and repaying debts on time. In addition to our confidence in New World achieving the above three goals, some buffers include cash on hand (around HKD 30 billion), a decline in HIBOR (100 bps drop could save the Group HKD 1.3 billion in interest expenses), potential rebound in property sales in Mainland due to the Government policy stimulus, additional financing from Hong Kong banks to NWD (which could be under the guidance and pressure of HKMA), asset disposal (including K11 Art Mall and K11 MUSEA) and other alternative measures (such as rights issues). The last resort would be the suspension of perpetual bond coupons (saving HKD 2 billion annually) and debt management measures.

 (The supplemental content in the last part of the article will cover the net cash flow analysis for the next two fiscal years.)

About offshore bonds (see Chart 1), NWD only has around HKD 1.3 billion in principal to be repaid over the next two fiscal years. The repayment pressure is quite manageable. The bond maturity wall is quite favourable, without significant principal repayments due in the short term. Due to the current tight liquidity situation of the Group, which missed the expectation, we believe that the Group would not call the two perpetual bonds (which have a reset date in next two years) in the first call date, until its liquidity improves.

Chart 1: Offshore Bond Maturity Wall

(The below supplemental content will discuss NWD’s net cash flows, which involve many assumptions, financial models and uncertainty, for reference only.)

The Situation may not be as Severe as Expected by the Market

Referring to past experiences in the Chinese property sector, the operational expenses and capital expenditures (including construction costs) and taxes will take priority over interest payments and debt repayment. On one hand, in Mainland China, under the concept of ensuring housing deliveries, the uncompleted pre-sold properties cannot be abandoned. In Hong Kong, the final payments of residential sales (which are significant) can only be received upon project completion. On the other hand, tax evasion in China is a serious offense, making these expenses unavoidable and placing them at a higher priority than the funds used for debt repayment.

Under our scenario assumptions (see Table 1 and Table 2), the net cash inflow for NWD should cover all the expenses, with net cash inflows of HKD 700 million and HKD 200 million in the next two fiscal years, indirectly suggesting that the situation may not be as severe as expected by the market.

In fiscal year 2027 or beyond, if the industry sentiment improves, together with the gradual completion of NWD’s investment properties in the pipeline, the Group should have more ways to raise funds for repayment of offshore bond principals.

Table 1: Estimation of NWD’s Cash Inflows in Next Two Fiscal Years

Table 2: Estimation of NWD’s Cash Outflows in Next Two Fiscal Years