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 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 $100 million of assets of one of its units. Kaisa’s
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’s 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
licenses 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 risk, 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 U.S., 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.
OFFSHORE INVESTORS SUBORDINATED
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 reorganization 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.
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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 prioritizing 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 percent homeownership rate,
against 65 percent in the U.S., 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 percent in the year to October, and new
home sales fell in 68 of 70 cities.
As we saw in the U.S., 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.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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