China firms' risk overstated: Merrill

Bond yield spreads now excessive; further price falls are hard to justify

Investors in bonds of Chinese real estate developers are pricing in too much risk of default, pushing spreads to record highs, analysts at Merrill Lynch said yesterday.

US dollar-denominated bonds of Chinese real estate developers such as Shimao Property Holdings and Agile Property Holdings have underperformed Asian and US high-yield securities, analysts led by Carolyn Chu said in a research note.

Credit default swaps and the yield of Agile's debt imply that investors are pricing in a 9 per cent chance of default by September and more than 50 per cent five years later, the investment bank said.

High-yield US home builders' bonds now trade at an average of 10.27 percentage points more than US Treasuries, according to a Merrill Lynch index that tracks 94 securities. The US$350 million 8.125 per cent bonds of Hopson Development Holdings now pay 11.36 percentage points more than US government debt, according to prices from ING.

'Amidst growing concerns of a US-led global recession and headline sensitivity of the Chinese property sector, we continue to underweight the sector,' the analysts said. 'However, we believe further price weakness from current levels is increasingly difficult to justify, whether on fundamentals or new supply concerns.'

It is unlikely that BB-rated developers will miss or delay bond coupon payments in the next six to 12 months, they said. Developers rated BB each have about 2 billion yuan (S$395 million) of bank loans due this year, according to the report. Banks have not refused to roll over maturing short-term loans of these companies, although lenders are charging an estimated 8 per cent in annual interest, up from 6-6.5 per cent in the first half of last year.

Government efforts to rein in lending to the industry and signs of slowing property sales in southern Chinese cities like Shenzhen and Guangzhou will make banks cut lending to the sector this year, the analysts said.

Investors have also been selling the bonds on concern of new debt sales by these companies, which need funds to buy land and projects. The Merrill analysts said that the concern is legitimate but more of a theoretical one in current market conditions. Any issuer of new public bonds 'in these markets is likely to find it extremely difficult to execute a deal, even if they are willing to pay up', they said. -- Bloomberg

Source : Business Times - 31 Jan 2008