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Interest costs, forex losses expected to hit Chinese developers' earnings

A weaker yuan makes interest payments for US and HK dollar debt more expensive

The yuan weakened to a 13-month low this week as expectations of further policy easing piled pressure on the fragile currency, which has fallen steadily since April.

Hong Kong

CHINA'S major property developers will report their first-half earnings next month, with some facing a sharp spike in interest costs and big foreign currency losses on overseas borrowing, and the hit could be harder in the second half.

The yuan weakened to a 13-month low this week as expectations of further policy easing piled pressure on the fragile currency, which has fallen steadily since April and suffered its worst month on record in June.

The currency is expected to come under more pressure in the second half if the trade disputes intensify.

That could spell bad news for the likes of Shimao Property and China Evergrande as a weaker yuan makes interest payments for US and Hong Kong dollar debt more expensive.

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According to JP Morgan estimates, Shimao's average interest rate for its offshore debt of 39.6 billion yuan (S$7.9 billion) is 5.3 per cent; the interest it was expected to pay in foreign currency for 2018 was 2.1 billion yuan, so for every 5 per cent yuan depreciation it will have to pay an extra 105 million yuan.

Evergrande has offshore debt of 134 billion yuan and its average interest rate is 7.5 per cent, so a 5 per cent fall in the yuan would increase its finance cost by 502.8 million yuan.

Overseas borrowing also creates foreign exchange liabilities when the dollar bonds are translated into yuan.

In 2015, when the yuan fell 5.7 per cent, some Hong Kong-listed Chinese developers posted foreign exchange losses of more than one billion yuan, in some cases wiping more than 6 per cent off earnings.

"2015 and 2016 were totally different environments, onshore rates were only 3.5 to 4.5 per cent on average, much cheaper than dollar bond rates. There was no forex risk and it was much cheaper so a no-brainer for developers to raise more debt onshore," said JPMorgan analyst Ryan Li. "But now onshore corporate bond issuance is not only tight but more expensive; the rates are 100-200 basis points higher than offshore."

According to his estimates, the direct impact from incremental interest costs and foreign exchange losses on Shimao's estimated profit this year would be around 25 per cent for every 5 per cent drop in the yuan.

In 2015, 48 per cent of Shimao's debt was denominated in foreign currency. The company's net profit fell 24.5 per cent that year, primarily because of foreign exchange losses.

Shimao lowered its proportion of US and Hong Kong dollar borrowing from 2016 by increasing onshore financing and redeeming offshore bonds, taking its foreign borrowing to 34 per cent of all debt.

But after China made it more difficult last year to get approval for onshore bonds and onshore rates outpaced offshore, Shimao's foreign debt exposure level rose back to around 43 per cent of all debt in the first six months of this year.

"We have no plans to borrow less offshore as we still try to balance lower offshore funding costs versus foreign exchange risk," said investor relations manager Eva Lau.

The company now hedges less than 10 per cent of its foreign currency-denominated debt due to high hedging costs.

The profit impact on state-owned companies China Jinmao and Sino-Ocean would also be around 25 per cent and 24 per cent respectively for every of 5 per cent drop in the yuan, according to JPMorgan estimates.

China Evergrande, which has an offshore debt exposure totalling 134 billion yuan, would see profit decline by 21 per cent per 5 per cent drop in the yuan. The yuan has fallen 1.9 per cent in the first six months of this year.

These drastic-sounding losses, however, will not necessarily hit dividends because forex losses arise from mark-to-market value and are not calculated in the companies' core profit, which excludes non-recurring items as such currency losses.

The impact on core profit, for example, would be 1.3 per cent for Shimao and 1.5 per cent for Evergrande.

"FX loss is non-cash ... hence not affecting dividend," Shimao's Ms Lau said.

Chinese developers are due to post their first-half financial reports in August. Shares in Chinese property companies have already fallen around 20 per cent since the second half of June, due in part to the yuan's decline. Some developers have chosen to not hedge forex risks, however, believing that expensive hedging tools are a double-edged sword.

"Renminbi fluctuation is a national direction ... it's difficult and expensive for companies to use swaps to hedge," said Simon Fung, chief financial officer of Hangzhou-based developer Greentown China.

Hedging would cost developers an extra 100 basis points, JPMorgan's Mr Li said. Not only is hedging expensive, the limited instruments available in China also cast doubt over its effectiveness. Currently, most developers use basic forward contracts. REUTERS

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