there is more than it seems
Chinese indebted real estate developers seeking private finance to buy out impending maturities have all the makings of a perfect storm.
The country’s real estate companies have huge offshore debt maturing over the next two years, given that they were recently among the biggest sellers of dollar bonds in Asia outside of Japan. But with the international bond market and loan market nearly closed for the sector – thanks to volatility emanating from the debt crisis of leading company China Evergrande Group – developers are increasingly looking for behind-the-scenes deals with private debt funds, GlobalCapital Asia understand.
There are little or no publicly available details of these illiquid private transactions, but it is understood that they mostly come with onerous terms and pay high prices – two areas of concern to market watchers.
Private debt financing, or direct lending as referred to in some parts of the world, has mushroomed globally since the 2007-2008 global financial crisis put a further drag on bank lending.
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By the end of 2020, direct loans – typically provided by non-bank lenders – topped $ 412 billion globally, according to Preqin estimates. The financial data provider estimates that assets under management for the Asia-Pacific private debt sector can reach $ 5 billion in 2025, up from $ 1.6 billion in 2019, with China at the center of that growth.
Due to its large scale and high margins, Chinese mortgage loans have attracted many direct lenders, ranging from global funds with deep pockets to midsize lenders. It has been even more critical recently. With many struggling developers, direct lenders have more opportunities to earn higher returns and better terms from companies they still see as investable.
In November, Yuzhou Group, a Chinese real estate company listed in Hong Kong, reportedly signed a $ 625 million asset-backed loan with Oaktree Capital Management. A portion of the proceeds will be used to buy back a $ 100 million private bond.
A group of investors, among the largest offshore bondholders in the Kaisa Group, are also seeking to inject $ 2 billion into the developer.
Direct lenders may have various funds under their umbrella to invest in a wide variety of situations. For example, New York-headquartered Marathon Asset Management has troubled funds and in September bought Evergrande dollar bonds.
GlobalCapital Asia understands that distress specialist SC Lowy recently launched a China-specific vehicle to increase its exposure to the real estate sector. Morgan Stanley funds are also said to be actively engaging with developers.
Private debt growth
Direct lenders are generally take-and-hold investors, but this can also include banks that can sell their risk to other return-hungry funds or use sophisticated hedging tools to minimize their exposure while spreading the risk. The greatest danger of private debt is its lack of regulation and the fact that holders of government bonds are generally unaware of this debt.
This is of course nothing new for China. Real estate developers have in the past raised off-balance sheet financing, which looks like equity but is debt-like in nature.
They have also given guarantees to joint ventures which borrow on behalf of the promoter. In many cases, companies have also used special purpose vehicles to issue debt, so the debt will not be included on the company’s balance sheet. So many ways to hide the amount of real debt of real estate companies.
But private financing comes with its share of challenges and conditions.
Lack of transparency, for its part, can have serious ramifications. That’s especially since developers have $ 52.3 billion and $ 45.9 billion in offshore maturities in 2022 and 2023, respectively, according to CreditSights estimates.
In addition, private debt financing is backed by collateral, ranging from physical assets to owner stocks. In the event of insolvency, this debt may take priority over others, inflicting unfavorable treatment on other creditors and stakeholders.
Take the example of the Indian company Vedanta Resources (VRL), based in London. A year ago, it was in talks with Oaktree for a structured $ 1 billion note ahead of plans to pull out its Indian subsidiary, Vedanta Limited (VDL). The three-tranche funding was expected to mature in 24, 30 and 36 months and yield approximately 13% return.
But the Oaktree Notes do have a pledge of fairness to VRL’s offshore subsidiaries – Finsider International Co, Westglobe and Vedanta Holdings Mauritius II. In comparison, government bonds guaranteed in dollars sold by VRL that did not offer collateral for shares of subsidiary guarantors. In addition, the Oaktree financing had strict prepayment terms, such as a high catch-up premium.
Of course, credit funds all have the right to protect their returns and the interests of their shareholders, which include insurers, pension funds and sovereign wealth funds.
But borrowers and investors also have an obligation to be transparent in their transactions. The Oaktree financing for Vedanta, for example, was taken at the level of an unlisted holding company. This meant that VRL did not have to provide all the details of the transaction. As the commodity cycle was on the rise, VRL’s cash flow improved and she had the option of not fully utilizing Oaktree’s facilities. But many Chinese real estate developers do not have this option.
Caution is the key
Real estate companies are in desperate need of liquidity and are also exploiting other avenues, such as selling assets and raising equity to bolster their liquidity. All of this is done in the hope that further easing policy measures and a rebound in the Chinese economy can stabilize their situation.
But that can easily backfire on increasing market volatility.
News of a new variant of Covid-19 called Omicron hit global markets this week. The Hang Seng Index has lost 3.62% in the past five days, while the Shanghai SSE Composite Index and the Shenzhen Component Index have lost less than 1% each. Comments by Federal Reserve Chairman Jerome Powell overnight in the United States that he should plan to cut support for the pandemic at a faster pace also caused unrest, with stocks falling. US dollars and the flattening of the US Treasury yield curve.
If developers continue to take the route of private financing on increasingly onerous terms, their future repayment pressure will be even higher.
History is full of examples of how unexpected events can strike a blow to even the most established businesses. Real estate developers should take a cautious and transparent approach to their fundraising activities or get caught.