Kaisa Defaults on $500M Bond Payment, Spooks Debt Markets

Chinese real estate developer Kaisa Group dug itself still deeper into default yesterday when the Hong Kong-listed company failed to make $26 million in interest payments due on offshore bonds.

The bond default is Kaisa’s second failure to meet debt obligations in the last nine days, although the company denied reports earlier in the week that it had decided to file for bankruptcy.

Kaisa’s has now made history as the first Chinese property developer to default on offshore bond obligations, and its failure has sent ripples through regional financial markets.

Fund managers and other investors had gorged themselves on Chinese real estate developer debt in recent years, often on the assumption that the Chinese government would always bail-out these largely state-linked enterprises.

Kaisa “Unsure” Whether It Met Interest Obligations

A representative of Kaisa said on Thursday evening, on the same day that the developer was to have distributed the interest payments to bond holders, that he was unsure if the company had met its obligations regarding the $500 million debenture. Kaisa had until midnight Hong Kong time to make make payment on the $500 million debenture, which is due to mature in 2020.

However, according to a story in the Wall Street Journal this morning, several fund managers that hold the bonds said they had not received any interest distribution from Kaisa.

The failure to make payment puts the company technically into default, although it has a 30-day grace period to fix the problem after missing the legal deadline.

Debt Obligations Building Up as Kaisa Fights Off Further Defaults

This latest default just adds to the debt pressure that has built up on Kaisa since December 31st, when two of its partners for projects in Shenzhen notified the company that they were demanding refunds on RMB 1.2 billion ($193 million) in fees.

The next day, Kaisa was notified by HSBC that it was in default on a HK$400 million ($51.6 million) loan.

Now the bond default adds another $26 million to Kaisa’s unpaid obligations, although the company insisted in an announcement to the stock exchange on Wednesday that it had not filed for bankruptcy, and was still considering how to work out its obligations to investors.

While China’s real estate industry has been mired in a more than eight-month slump, Kaisa’s inability to meet its financial obligations is puzzling to many analysts considering that the company’s latest financial statements, from June of last year, showed that it had enjoyed a net profit in the past six months of RMB 1.33 billion, and had cash reserves on hand of RMB 9.38 billion versus short-term debt obligations of RMB 6 billion.

Is Kaisa Dying by the Sword?

Kaisa’s current crisis is particularly worrying to observers of China’s real estate industry for the way that it shows how a company that grew rapidly thanks to government connections, can fail even more quickly once officialdom changes direction.

The Shenzhen-based company made fabulous profits since it was founded in 1999 in the same way that most Chinese property developers do. By knowing the right people (in the government) to be able to buy prime land cheaply, and by having the right contacts (at government banks) to gain access to cheap credit.

The current troubles for the property developer appear to be triggered by changes in the government in Shenzhen, which have tainted the once-high flying company (Kaisa was ranked as China’s 17th largest developer in 2013) as being associated with the wrong decision-makers, just as China’s government launched the most widespread anti-corruption campaign in decades.

Last October a high-ranking official in Shenzhen’s Longgang district was detained for investigation into corruption which allegedly involved crooked real estate deals.

In November there were rumours, which were never substantiated, that Kaisa boss Kwok Ying-shing had also been detained. In any case, Kwok later announced that he was selling a large chunk of his shares and publicly resigned from the company on December 13th.

Kwok’s departure appears to have been too little too late for the developer, however, as the Shenzhen government had already frozen sales at three of its projects in the southern Chinese metropolis on December 4th, and halted sales at a fourth project on December 21st.

All four projects were in the pre-sales period when developers most need cash to finish construction, and the moves by the city government that once served as Kaisa’s springboard, effectively cut off Kaisa’s cashflow from the city. The developer had traditionally generated 20 percent or more of its revenues from the Guangdong mega-city.

Offshore Appetite for Developer Debt Likely to Dry Up

For now, Kaisa’s future remains unclear. The developer’s board, which is made up largely of newcomers appointed after Kwok and two of his other board members left last month, has yet to make any statements to the stock exchange or investors since it officially denied the bankruptcy filing on Wednesday.

According to a report today in the Shanghai Securities News, state-owned insurer Sino Life, which is now the second largest shareholder in the company after Kwok, and which effectively controls the board at this point, is waiting to see what the Shenzhen government will do before taking any further actions.

Should Kaisa continue to miss debt obligations, its defaults and de-facto bankruptcy are likely to frighten off investors who would have previously considering buying Chinese developer debt. This market scare is like, in turn, to raise the cost of financing for an industry that is already struggling with several months of sluggish sales.

According to a report yesterday in Reuters, bonds for other Guangzhou-based developers, such as Guangzhou R&F Properties and KWG Property Holdings Ltd have fallen by 7-10 points this month, with KWG’s 2020 bonds now yielding over 21 percent compared to about 14 percent during December.

With few precedents for work-outs of Chinese offshore debts, investors are understandably worried. When Chinese companies in other industries defaulted in 2009, investors were eventually able to reclaim only about 20 cents on the dollar for their bond holdings.