Kaisa Saga

The recent financial crisis of the Kaisa Group Holdings Ltd. (“Kaisa”), a Chinese property developer listed on the Hong Kong Stock Exchange (“SEHK”), is leading to what could be the first offshore1 bond default by a Chinese property developer. This is causing alarm in an important but already troubled sector in the PRC.

Although the company had been in the headlines for several months (on allegations that its chairman was under investigation by government authorities in the PRC, which the company has denied), the Kaisa saga began with the resignation of the group’s chairman, which triggered the prepayment provision of a US$400 million loan to the HSBC Holdings PLC. Credit rating agencies Standard & Poor’s and Moody’s Investors Service have downgraded Kaisa’s debt to ratings that reflect an expected default2. Kaisa has missed an interest payment of about US$26 million on January 8, 2015 on its US$500 million 10.25% offshore bond due in 2020. On January 7, 2015, Kaisa has received a waiver from the HSBC on the breach of its loan in respect of the resignation of the company’s chairman, thus it is no longer required to repay the outstanding loan immediately, so giving it time to devise viable repayment proposals3. However, several of its bank accounts have been frozen and put under investigation by several banks4. Various applications in relation to the preservation of group assets have also been filed by creditors5, hurting its ability to sell off projects to raise funds and pay back lenders. On January 9, 2015, it received a civil ruling from a court in Mainland China6 in relation to the preservation of assets of a member of the Kaisa group amounting to about US$105.08 million (RMB 651.15 million7). As of January 16, 2015, Kaisa’s stock remains suspended from trading on the SEHK. The company has a 30-day grace period to pay after the due date of the interest payment of its US$500 million offshore bond, which is expected to expire on around February 7, 2015. Using onshore8 cash to pay an offshore debt would require approval from China’s State Administration of Foreign Exchange and may take several weeks. The clock is ticking.

There are various players at stake in this crisis – onshore bank lenders, trust lenders, home buyers as well as offshore lenders and bondholders. It remains to be seen how the PRC government will approach this case. However, at least the government of Shenzhen, where Kaisa is based, has not appeared to be supportive – as Kaisa said, certain pre-sales at four property projects in Shenzhen were blocked according to the website of the Urban Planning Land and Resources Commission of the Shenzhen Municipality, but they have not received any notification from the authorities despite enquiries9. Amongst other restrictions and suspensions imposed on Kaisa’s operations or projects by the PRC authorities, routine applications for licenses, permits, approvals, registrations and filings that are necessary during the different stages of development of eight projects in Shenzhen had also not been accepted10.

The Troubled Sector

The Kaisa crisis has triggered broader concerns for the PRC property market and its ability to continue accessing offshore funding markets. Offshore investors have been purchasing Chinese property debt in droves and willing to accept unsecured bond structures, whereby they are deeply subordinated to onshore lenders11. There is a total of US$55.7 billion worth of outstanding G3 bonds from the PRC property market, which accounts for roughly half of the high-yield borrowers in Asia outside of Japan12. Some US$6.6 billion of it matures in 201513.

According to a commentator, the PRC property bond market is an overheated sector and probably one of the main weaknesses in the PRC economy14. Property bonds were attractive to international investors because of the high yields on offer and a belief that any Chinese borrower running into trouble would be kept afloat by bailouts or debt extensions. Now the mood has changed. As we see the PRC government moving away from an interventionist culture since the first onshore bond default that occurred in Mainland China on March 7, 201415, a bailout seems unlikely for Kaisa.

The potential for a default by Kaisa is adding to the pressure on PRC’s heavily indebted property market, which already is struggling with a weak housing market and difficulties in raising cash to pay back loans amidst economic slowdown. The prices of debt issued by other midsized PRC property developers, such as Agile Property Holdings Ltd., KWG Property Holding Ltd. and Country Garden Holdings Ltd., has fallen since the beginning of 2015, sending yields to as high as 13%, compared with single digits last year. Kaisa’s bonds currently yield in a range from 48% to 92%. Bond yields rise as prices fall16. While the People’s Bank of China cut interest rates in 2014, for the first time since 2012, to help support the real estate industry, new-home prices still fell in 67 of 70 cities in November, 201417. The country has approximately two to three years of unsold supply of properties in many major cities. An 80% homeownership rate implies limited un-met demand18.

One of the troubling factors in the Kaisa saga is how Kaisa appears to be financially sound with a healthy portfolio of commercial and residential projects, strong sales and solid cash flow. It has around US$1.45 billion (RMB 9 billion) in unrestricted cash as of June 30, 2014 versus a short term debt of US$970 million (RMB 6 billion), according to Deutsche Bank AG, and its net profit in the first half of 2014 rose 30% versus the previous year to US$214 million (RMB 1.33 billion). It employed about 9,500 people as of mid-2014, and was ranked number one in residential property sales in Shenzhen during the first half of 201419. Such situation may heighten market fear, making foreign investors wary of PRC property bonds overall and anxious about whether other seemingly healthy companies in the sector could melt down as well20.

While some observers consider Kaisa an isolated event, others fear that more defaults in the PRC property market are likely to follow. If there is a crisis of confidence, it may create spiralling effects on the PRC property market. According to a commentator, the Kaisa incident is part of the consolidation process of the PRC property market21.

A Test Case for Offshore Investors?

Kaisa’s troubles are particularly worrying for offshore investors, who have little, if any, protection against companies in Mainland China in the event of insolvency. They receive payment long after domestic investors and have no direct access to assets in Mainland China because of capital restrictions.

If Kaisa does default on its offshore bonds, it could be a test case for foreign investors seeking to recoup losses from troubled companies in Mainland China. It will be interesting to see how this is processed – the length of time it would take and how much of its assets foreign investors would ultimately receive.

The precedents are limited and discouraging. When Asia Aluminium Holdings Ltd., an aluminium extrusion company, defaulted on its offshore bonds in 2009, there were low levels of recovery below 20 cents to the dollar22. Offshore creditors received very little in that default scenario. For property companies such as Kaisa, even if it is liquidated, the company has plenty of physical and tangible assets it can sell to raise cash, so one would hope that there could be a higher recovery rate. However, it is unclear how much of these would go to international investors.

Future for Real Estate Financing

The risk appetite for the PRC property market is likely to be severely dampened if offshore investors end up taking big losses in Kaisa’s crisis, which will make it difficult for weak high-yield property developers to refinance maturing bonds and loans or to obtain fresh financing.

The crisis of one of the stronger players of the PRC property market and the uncertainties that characterize the Kaisa saga underline the need to price in a higher risk premium for Asian, particularly PRC, high-yield bonds. Risk premium being priced into the PRC property market was perhaps too low previously. Offshore investors are reminded to factor in the uneven playing field risk, as they are subordinated to onshore, Mainland China creditors in the event of insolvency.

Political risk premium, in particular, must be seriously evaluated when considering the value of the bonds. Some 75,000 officials have been investigated by the Central Commission for Discipline Inspection since President Xi Jinping took power in 2012. According to a commentator, probes into corrupted officials are often found with links to business people23.

Transparency cost is another one to add to the risk premium – even for a listed company subject to the disclosure obligations of the Hong Kong Listing Rules. The lack of transparency in the PRC financial sector is a debilitating factor for the PRC property market, further affecting investor confidence particularly in the midst of economic slowdown, and what could be the first default of offshore dollar bonds in the PRC property market.

1.   “Offshore” in this article refers to the jurisdiction outside of the PRC. “PRC” in this article refers to the People’s Republic of China, excluding Hong Kong, Macau and Taiwan. 
2.   “Chinese Developer Appears to Default” by Wayne Ma and Fiona Law, Wall Street Journal, January 8, 2015.
3.   According to the announcement made by Kaisa on January 12, 2015, see
4.   See footnote 3.
5.   See footnote 3.
6.   “Mainland China” in this article refers to the geopolitical area under the jurisdiction of the PRC, excluding Hong Kong, Macau and Taiwan.
7.   See footnote 3.
8.   “Onshore” in this article refers to the jurisdiction of the PRC.
9.   According to the announcement made by Kaisa on December 21, 2014, see
10.  See footnote 10.
11.  “China property facing key Kaisa test” by Denise Wee, Finance Asia, January 7, 2015.
12.  “Kaisa Default Fears Hit Property Bonds” by Fiona Law, Wall Street Journal, January 7, 2015.
13.  According to data provider Dealogic. See footnote 12.
14.  According to Michael Ganske, head of emerging markets at Rogge Global Partners Plc. based in London. See “There’s a Leadership Crisis in Chinese Property Firms – They’re Defaulting. Who’s Next to Go?” by David Yong and Christopher Langner, Bloomberg, January 7, 2015.
15.  For more information, see our articles on “China’s First Onshore Corporate Bond Default and Its Implications for the Country’s Debt Capital Market” by John Chrisman, Christopher W. McFadzean and David Richardson, World Securities Report, Bloomberg BNA, April 2014:
http://www.dorsey.com/files/Upload/China-Onshore-Corporate-Bond-Default-Debt-Capital-Market-april2014.pdf; Shedding Light on China’s Massive Shadow Banking Market – Landmark Corporate Bond Default – Part 1 by John Chrisman, Christopher W. McFadzean and David Richardson, March 12, 2014: http://www.dorsey.com/eu-chinas-shadow-banking-market-landmark-corporate-bond-default-pt1/.
16.  See footnote 13.
17.  “Kaisa Dollar Bonds Rally as Developer Gets Loan Default Waiver” by David Yong and Christopher Langner, Bloomberg, January 13, 2015.
18.  “Kaisa is an object lesson in the perils of China” by James Saft, IFR Asia, January 13, 2015. 
19.  According to
www.SZHome.com, an industry website. See footnote 2.
20.  See footnote 2.
21.  According to Chi Lo, Greater China economist at BNP Paribas Investment Partners. See “Kaisa default risks waking China property bears” by Josh Noble, Financial Times, January 13, 2015.
22.  See footnote 12.
23.  “Kaisa said to be probed on ties to official under investigation” by Bloomberg News, Bloomberg, January 13, 2015.