China's defaulted property developers are not out of the woods. Repeated and longer extensions on their bond maturities may provide breathing room but they are also a stark indication of a deterioration in liquidity. The extensions also signal more time is needed for serious repair.

If defaulted developers can raise equity and restore their balance sheets, there's hope. But we must wait to see how a new government support policy plays out and whether property sales can be revived. There is also a risk certain measures could inflame the subordination risk of offshore debts.

Waiting Game For Bondholders

Since July 2022, the casualties in China's property sector have been piling up, and chief among them are private developers. Several key factors explain the ongoing weakness in the sector: COVID-19 restrictions have curbed movement and thus property-buying; a mortgage boycott has dented homebuyers' confidence; funding channels have closed; and regulation has choked cash movement from pre-sales escrow accounts to holding companies.

Developers had asked bondholders to extend the maturity dates on their bonds. But amid the weak property market, some developers remain unable to repay and have again asked bondholders to accept maturity extensions. This includes requests for holistic extensions whereby the issuer gives bondholders a package deal to either extend or exchange--or both--all its bonds (onshore or offshore) at the same time.

Put Up Or Shut Up: The Creditor Resistance Builds

Requests for longer bond extensions increasingly face a wall of creditor resistance mainly because of inadequate compensation. In some cases, creditors have vetoed developers' extension proposals, or are calling for court intervention to have insolvent companies wound up.

Jinke Property Group Co. Ltd. (NR) is an example. In the second bondholders meeting in 2022, the company failed to receive approval from bondholders to extend its Chinese renminbi (RMB) 1 billion (US$137 million) 5.58% medium-term note due 2023.

The group finally managed to get sufficient support in a later bondholders meeting. However, it still failed to pass a proposal to waive its obligation related to certain preset clauses, including cross protection and change of control, as well as a proposal to add a grace period in the event of default.

And there have been more and more offshore wind-up petitions from creditors. On Oct. 17, 2022, a winding-up order was issued against an offshore subsidiary of Yango Group (NR), requiring this subsidiary to be liquidated under court supervision. Other defaulted developers, including China Evergrande Group (NR) and Sunac China Holdings Ltd. (NR), are also facing offshore wind-up petitions.

Rescue Yes, But Not For All

A new government support package will help some but not all--particularly defaulted developers. In November 2022, regulators unveiled extensive policy support that had three broad aims: ensure housing delivery; ease the liquidity strain on developers; and encourage the acquisition of projects.

S&P Global Ratings does not believe the recent policies aim to bail out creditors. Instead, they set a floor for the downward spiral for the sector and attempt to restore equal treatment by lenders and investors of state-owned enterprise (SOE) and privately owned enterprise (POE) developers. The policies are mainly market-based solutions and may benefit SOE and high credit quality POE developers more than defaulted developers.

For example, six big SOE banks have already provided an uncommitted credit line of about RMB1.3 trillion for at least 17 developers, according to local reports in November 2022. Most of them are top players and many of them SOE developers, including Longfor Group Holdings Ltd. (BBB-/Negative/--), China Vanke Co. Ltd. (BBB+/Stable/--), and Midea Real Estate Holding Ltd. (NR).

Currently, the government's rescue package mainly supports funding for the delivery of property projects and financing by high-quality companies. It remains to be seen if the package will help defaulted developers to secure funds to service holding-level debts, particularly offshore debts.

Recent media reports speculate that regulators may have guided some state-owned banks to extend offshore loans to developers backed by their onshore assets to repay offshore debt. This would help restore investors' confidence if developers are able to tap this channel for debt repayment.

That said, developers that have good quality assets, especially those with rental and investment properties, are more likely to be the beneficiaries.

Additionally, allowing defaulted issuers to raise equity funding from both onshore and offshore stock markets could facilitate deleveraging and balance sheet repair (table 1). However, this is a tough proposition for investors if the company's future as a going concern is uncertain.

Table 1

Implications: Subordination Risk Of Holdco Level Debts

Housing delivery remains the policy priority even though credit conditions for developers have been loosened. In mid-November, the banking regulator and central bank decreed a 16-point plan to stabilize the industry. The measures include credit support for indebted housing developers, financial aid to ensure completion and handover of projects to homeowners, and help for deferred-payment loans for homebuyers.

Under these measures, outstanding bank/trust borrowings due in the next six months could be extended by another year. And bond issuers are encouraged to negotiate bond extensions and exchanges when they have difficulty in repaying bonds on time. We believe debt extension can focus resources on project construction and delivery to homebuyers.

We believe the main purpose of rescue loans remains project construction and delivery. As such, the projects of defaulted developers could also access the rescue funding. The rounds of support in November 2022 should add RMB1 trillion of fresh liquidity to the sector (see "China Property Is Heading For A Transformation, And Maybe A Turnaround," Nov. 20, 2022).

That said, rescue loans for projects could occupy a higher rung in the repayment hierarchy than existing debts. Under the "last in, first out" principle of the 16-point plan, the projects' cash from collection will be prioritized for the repayment of newly obtained special "housing delivery" loans from policy banks and for the repayment of financial institutions' supporting funding associated with projects receiving special loans.

In this way, support measures will alter the repayment hierarchy. Extending existing project loans and holdco debts to meet the goal of prioritizing project delivery means existing creditors get paid later than rescue fund providers. This additional layer of creditors at the project level would increase the subordination risk of offshore debts, which are issued at the holding company level.

Given the policy focus of protecting homebuyers, it could make sense for developers to prioritize the repayment of domestic borrowings at the expense of the offshore creditors.

After all, domestic borrowing are the main sources of funding for developers' construction.

By maintaining debt service current on their onshore borrowings, developers can continue to access rescue funding even though they have defaulted on offshore creditors.

Favoring onshore borrowers in payment comes with its own risks. The risk is offshore creditors losing patience as they do not see a path forward for their claims. This could lead them to file for winding up.

Different Issuing Entities

Typically, developers have different entities both onshore and offshore to raise borrowings. A case in point about different issuing entities onshore and offshore is CIFI Holdings. The company suspended payments on all its offshore debt issued by CIFI Holdings (Group) Co. Ltd. (NR), offshore issuing entities, after failing to reach an agreement with creditors to whom it owes a total of US$414 million.

But at the same time, the onshore operating entity CIFI Group Co., Ltd (NR) continued to repay onshore bonds, including a corporate bond's interest payment due in October.

In December 2022, CIFI signed RMB10 billion in credit lines with the Shanghai branch of Post Savings Banks of China, as well as several fresh credit lines of unknown amounts with a few other onshore banks. These lines are uncommitted in nature, and the actual drawdown needs to be approved on a case-by-case basis. However, they showcase support from financial institutions, despite the fact CIFI Holdings defaulted on offshore bonds.

The offshore creditors may ask for credit enhancements, including using onshore assets for collateral, when negotiating extensions or restructuring plans with issuers. That said, it may depend on bargaining power, and may need no objection from onshore creditors. Government help could facilitate such negotiations.

Debt Haircut Risk Remains

Overshadowing the rescue package is the risk of debt haircuts. While the package may ease liquidity pressure for developers, it would also add new debts and increase the debt burden of the developers at a time when property sales have plunged and a recovery is uncertain.

If property sales are insufficient to cover all debt, it would mean insolvency. Repeated missed payments and debt extensions would stretch investors' patience and lead to petitions for in-court debt restructuring to give a new lease of life to the defaulted developers. A hair cut would be inevitable.

Cash Recovery: A Reference Point

The cash recovery rate for non-property sectors suggests a reference point for what bondholders might expect. Cases of property developers that have endured the complete restructuring process are limited.

It's therefore worth examining the past cash recovery rate of the non-property segment. This is particularly so given the heightened subordination risk, and the fact offshore investors have limited ability to access onshore assets to boost their recovery prospects.

Our study suggests that the cash recovery rate for non-property corporates' in-court offshore bonds is about 27%; and out-of-court restructuring is about 45%*. We do not formally assign recovery ratings for debt issued by Chinese corporate issuers since we have not assigned a jurisdiction ranking assessment for China. This study thus serves as a good reference point.

A Recovery In Home Sales Is Crucial

The most important source of funds for debt servicing is sales. The longer extension gives developers more room to breathe. But the final post-default recovery value for creditors chiefly depends on sales and the cash collection. So far, the signs aren't positive. S&P Global Ratings expects new home sales to finish 2022 at RMB13 trillion-RMB13.5 trillion, down 28%-33% year on year, and forecasts a further decline of 5%-8% to RMB12.5 trillion-RMB13 trillion in 2023.

The recent policy support sets a floor for the crisis. That said, we expect it will take several quarters to flow into the physical market. We continue to expect an "L"-shaped recovery, with a recovery possibly in the second half of 2023.

Furthermore, the sales of distressed developers are likely to remain weak and continue to underperform the market, especially since confidence in weak entities remains low. Similarly, the tide of the housing market recovery will not lift all boats--especially the distressed developer kind.

Distressed developers are hoping sales recover before their extended maturities fall due. Otherwise, haircut risk seems all but inevitable.

Related Research

• China Property Is Heading For A Transformation, And Maybe A Turnaround, Nov. 21, 2022
• Credit FAQ: China's Defaulted Developers Are Running Out Of Time To Exchange And Extend, July 17, 2022.
• China's Surging Defaults Test Courts And Bond Recovery, May 5, 2022

Writer: Lex Hall