Another Chinese property developer is in trouble. Here’s what it means

China’s property sector woes continued this week as another big property developer found itself in trouble. AMY XIE PATRICK explains

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China’s property sector woes continued this week as another big property developer found itself in trouble.

Privately-owned Country Garden — China’s biggest property developer based on last year’s contracted sales — missed US$22.5 million in payments on two bonds.

The company is described as facing “periodic liquidity stress” in a Reuters report. In other words, it’s running out of money.

The bonds now enter a 30-day grace period. To avoid a default, Country Garden must find enough funds to meet coupon payments before the grace period expires.

The market has been bracing for more trouble since a spate of property sector defaults in China during 2022 — including the high-profile default of Evergrande.

At the end of July, Country Garden’s US dollar bonds were trading at 20% to 25% of face value. A high risk of default had been priced in.

Now that two coupon payments have been missed, the probability of default has skyrocketed, causing bonds to dip further to 8c on the dollar, closing in on all-time lows seen last November.

The market values these bonds at such low recovery rates because of rules in China that restrict foreigners from owning physical assets onshore.

If Country Garden defaults on the bonds, it’s likely creditors on their US dollar denominated senior unsecured bonds would stand behind onshore equity holders in the queue to get their money back.

What’s next?

On this occasion, Country Garden will probably find enough money to pay the coupon within the 30-day grace period.

The company’s chairwoman holds stakes in Country Garden Services, an affiliated entity and is expecting a dividend payment of around US$60 million this month.

One could speculate that some of those funds are already slated for curing the missed coupon payments.

But this doesn’t solve the “periodic liquidity stresses”.

For the remainder of the year, Country Garden needs to find US$2 billion of funds to satisfy other payments of principal and coupon on outstanding US dollar denominated bonds.

On top of this, the company needs ongoing cash to complete projects already pre-sold to customers.

As the confidence crisis in the property sector deepens in China, the feedback loop has been vicious.

Levered property developers need strong and sustained momentum in new pre-sales to fund the completion of older pre-sales.

In Country Garden’s case, a minimum of monthly contracted sales of RMB 28-30 is needed to complete a pipeline of earlier pre-sold homes.

In 2021, monthly sales averaged around RMB 40-45 billion. Today monthly sales are down to around RMB 12 billion and falling.

This is what is causing the “periodic liquidity stress” — though I would describe it as existential rather than periodic.

An end to endless demand

The breadth of Country Garden’s operations is vast.

Many of its unfinished projects are in China’s third-tier (or lower) cities.

When the population thought property prices could only go up, these cities benefited from endless demand. But the current crisis has turned everything on its head.

Populations in these less prosperous are in net outflow. These are not the cities that first-time buyers are rushing to anymore.

The company considered an equity raise, but decided to scrap the idea at the end of last month, likely as a result of “no takers” after testing the waters for indications of interest.

The only hope left is help from the government. So far, Beijing is not rushing to their “model” developer’s aid.

Hundreds of thousands of buyers waiting on delivery of Country Garden homes could be affected if the company goes to the wall.

Half-finished building projects would freeze while assets were sold, haircuts negotiated, and left-over funds paid out.

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But it is one way to break the vicious cycle between defaulting developers and plummeting buyer confidence.

With the right haircut, the assets of Country Garden are attractive to other developers in a stronger liquidity position.

A default at Country Garden forces the company to take these inevitable haircuts, and lets stronger companies resume the completion of unfinished projects.

Once buyers started getting delivery of finished homes, the urgency to dump these homes at fire sale prices in the secondary market would start to reduce, allowing home prices to stabilise.

Stable house prices then lead to a more stable confidence around the sector and the economy more broadly.

This is not the sugar hit the market has hoped for. But it is likely the structural change that is badly needed in the Chinese economic growth model.

In the meantime, we expect a slight loosening of restrictions on developer access to funding, to prevent a domino effect of Country Garden’s current cash crunch on the rest of the sector.

What it means for global growth

The investment implications from the latest casualty in China’s property crash are fairly straightforward.

China’s weight on the global growth picture will become more apparent as the rest of the world burns through its buffers.

That means being more overweight in duration of developed markets than through China bonds directly.

As China tries to pull other levers to lessen the pain, a weaker currency becomes the easiest release valve. Buy US dollars against the yuan on dips in the pair.

And as China races ahead on electric vehicle production, tread with caution on traditional autos sector exposures.

Most are finding it hard to keep up with the fast-growing Chinese alternatives.