Deutsche Bank Says Buy China Builder Debt on Loan Easing

By Bloomberg News

Photographer: Brent Lewin/Bloomberg

Residential and commercial buildings stand illuminated at night in the Sanlitun area of Beijing, China.

Falling prices for Chinese developer debt and easier home loan rules prompted Deutsche Bank AG to put out a buy call. Morgan Stanley says that’s premature.
Dollar-denominated high-yield notes issued by Chinese builders have returned 5.4 percent this year, the least in three years after gains of 8.5 percent in 2013 and 47.9 percent in 2012, Bank of America Merrill Lynch indexes show. The securities have returned only 0.1 percent since July. Deutsche Bank, the world’s leading underwriter of junk bonds, said the slowdown has made the debentures attractive and developers’ credit quality will benefit from central bank support.
“Mortgage easing is a pivotal point and has supported home buyers’ sentiment,” said Jacphanie Cheung, a Hong Kong-based analyst at Deutsche Bank who
visited the cities of Fuzhou, Changsha, Wuhan and Zhengzhou in mid-October. The policy “could be more effective in stimulating demand than a cut in the benchmark interest rate,” she said.
The view contrasts with Morgan Stanley, which said investors should avoid developers because easing steps won’t immediately revive an industry the World Bank says accounted for 16 percent of China’s economic growth last year. While home sales jumped 40 percent on month in September, prices dropped in all but one city. The collapse of a builder near Shanghai in March, tighter rules on shadow banking and detention of executives amid a corruption probe have added to concerns.

Prices Slide

The price of Agile Property Holdings Ltd.’s perpetual notes has slid 20 percent this year after billionaire chairman Chen Zhuolin was confined by prosecutors in September. The 2018 bonds of Evergrande Real Estate Group Ltd., a developer that has expanded into soccer team ownership and baby formula, have dropped 8 percent, data compiled by Bloomberg show. Debentures due that same year from Kaisa Group Holdings Ltd., a Shenzhen-based builder, have slumped 2 percent.
“Overall, it’s a challenging environment for property developers,” said Viktor Hjort, Hong Kong-based head of Asia fixed-income research at Morgan Stanley. “Only after they have run down inventories and deleveraged balance sheets, can the sector have an outlook for balanced supply and demand. That will be a fairly drawn-out process.”

Debt Mounts

The number of publicly traded real estate firms with liabilities exceeding equity has increased to 136 out of 334 from 57 in 2007, according to data compiled by Bloomberg. Moody’s Investors Service and Standard & Poor’s have warned that Renhe Commercial Holdings Co., a developer of underground shopping centers, has the highest risk of defaulting next year.
Goldman Sachs Group Inc. downgraded the Chinese real estate sector to negative from neutral on Sept. 4, citing, among other things, worsening leverage and rising stock of unsold homes. Notes from the country’s builders are the riskiest part of Asia’s bond market, it said in a Oct. 27 report.
Steve Drew, head of emerging-market credit in London at Henderson Global Investors, which managed the equivalent of $121 billion as of Sept. 30, said he is underweight China property bonds as he expects a tick-up in bad loans and defaults next year even with stimulus. That means he holds less of the debt than the benchmark used to gauge performance.

Policy Shift

Premier Li has ended a four-year campaign to contain home prices as he seeks to meet a target for economic growth of about 7.5 percent this year. Local governments in 37 out of 70 major cities have relaxed home-purchase restrictions, according to a Moody’s report last month. The central bank on Sept. 30 allowed homebuyers who have paid off existing loans to take out new mortgages.
As authorities ease monetary conditions the yield on the 10-year government bond has declined 99 basis points this year to 3.56 percent.
China will “stabilize” property-related consumption and make it easier for people to access mandatory housing savings, the State Council said in a Oct. 29 statement. Developers are also taking steps to trim expenditures, with 35 builders tracked by Deutsche Bank decreasing their spending on such acquisitions to 29 percent of their contracted sales this year from 38 percent last year.

‘Positive Outlook’

Deutsche Bank recommends investors shift assets to high-yield Chinese property notes from investment-grade peers, and prefers securities from the nation’s real estate industry rather than from industrial companies.
“Given our positive outlook on developers’ sales, together with potentially lower capital commitment for land purchases and construction, we are more optimistic on the credit outlook on developers for next year than this year,” said Cheung.
Nikko Asset Management Asia Ltd., which oversaw $168 billion of assets at the end of June, is neutral to slightly underweight as it wants to see inventories fall further, according to Leong Wai Hoong, senior portfolio manager in Asian high-yield bonds.
“The physical market is improving and has probably found a floor as some easing measures are having some positive impact on home sales,” Singapore-based Leong said. “It boils down to whether the bonds are offering enough premium, and whether we are comfortable with the level of corporate governance.”