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China developers head home, but offshore bonds set to hedge political risk

Chinese property developers are wary about relying too heavily on onshore funding, even after regaining access to the cheaper domestic bond market.

[HONG KONG] Chinese property developers are wary about relying too heavily on onshore funding, even after regaining access to the cheaper domestic bond market.

Evergrande Real Estate and Longfor Properties last week became the latest Chinese developers to cut their interest costs through the issuance of domestic bonds.

The move onshore is expected to continue, after China Vanke, Guangzhou R&F Properties and Times Property recently received approvals from the China Securities Regulatory Commission.

Evergrande and Longfor are paying coupons nearly half those on their offshore US dollar bonds, taking advantage of falling interest rates in a domestic market that was closed to Chinese developers until last year.

However, issuers are aware that government policy can change quickly, while offshore markets remain immune from political interference. "The (onshore) channel of refinancing is limited and is always decided by the central and local government, so it's not as reliable as the offshore high-yield bond market," a funding official at a Double B rated developer said. "If it's cheaper, it's more attractive for the company, but, sometimes, the window will close. Developers, in general, will prefer to use the two financing channels because, in China, these depend on the market and policy." Offshore debt issuance from PRC property companies has fallen sharply this year and some industry sources expect offerings this year to drop by nearly half from the US$8.9 billion in 2014. "We expect offshore bond issuance amounts this year will be below the levels seen in 2014 and 2013 due to the relatively small volume of maturing offshore bonds, the opening up of alternative onshore funding channels, as well as the slowdown in land acquisition by developers," said Franco Leung, a senior analyst at Moody's. "Issuers are broadly attracted to domestic bond issuance due to lower costs of funding." The funding official, however, said companies were unlikely to turn to the domestic market to replace overseas high-yield bonds.

Instead, issuers may use the onshore markets to replace higher-yielding local borrowings. That may be especially attractive to developers, which, in recent years, had turned to high-margin loans from trust companies. Onshore bonds also carry fewer restrictions on the use of proceeds than loans from Chinese banks.

Reducing interest costs remains a focus. "We were told by rating agencies that if our annual rental income could cover annual interest costs, we could have our ratings raised to investment grade," said the official. "We might get an investment-grade rating by the time our maturities come due, so we might have a really good chance when we issue our offshore refinancings." Moody's upgraded its outlook for the China property industry to stable from negative last month, citing improved access to funds onshore as one of the reasons for the change.

The rating agency said the gradual reopening of the onshore bond markets would help mitigate the impact of tighter government supervision on shadow bank financing.

Late last year, the CSRC began granting permission to property companies to sell debt to onshore PRC investors, ending a years-long freeze aimed at cooling property prices.

Last week, Evergrande priced bonds of 15 billion yuan (S$3.2 billion) in tranches of four and seven years to yield 5.3 per cent and 6.98 per cent, respectively.

Despite the larger size, the onshore coupons were much lower than the 12 per cent yield on a US$1 billion five non-call three note it printed in February. The onshore yields are also much lower than the company's average funding cost of 9.74 per cent in 2014, according to S&P.

The looser restrictions coincide with four interest cuts by the People's Bank of China as part of efforts to boost lending to support a weakening economy, making onshore rates more attractive.

The latest cut at the end of last month reduced China's one-year benchmark lending rate by 25bp, accompanied by a lowering of 50bp in the reserve requirement ratio for certain banks.