Given the centrality of the property market to the Chinese economy, mounting developer debt has understandably become an undercurrent for investor concern. With this very real scenario unfolding, many are asking why are debt solutions rising in prominence in China and across Asia Pacific, and attracting broad investor interest?
While just two percent of renminbi debt has been issued by developers this year, Chinese developers’ onshore borrowing will rise to 55 billion USD in 2019, quadruple the value of offshore, USD denominated loans. A key challenge domestic developers now face is repayment of these loans as maturity looms under the cloud of a deleveraging campaign and imminent US Fed interest rate hikes rippling through to Asia.
There is more than meets the eye, though, when looking onshore debt figures. While renminbi denominated loans seem colossally sized, it’s not likely that this alone constitutes a weapon of mass destruction. Onshore debt access continues to have an aura of exclusivity surrounding it, whereby a select few large developers are granted regulatory approval.
As for offshore debt, this segment of capital markets is largely occupied by overseas-listed Chinese developers, many of whose debt is maturing in the next year and need to seek refinancing Now facing escalating financing costs due to US Fed rate hikes, this group must manage the additional risk of exchange rate fluctuations, tightening US dollar liquidity and a depreciating yuan. Perhaps adding to the pressure of this group is a brewing trade conflict, will see further downward pressure on the yuan, thus rendering the repayment of dollar debt more difficult. The situation that ensues will likely be one where more debt is taken on to finance existing debt, the snowball effect of which could have larger implications for the economy.
As Chinese banks rein in lending to the property sector and redivert these funds to the real economy, the gates to alternative funding for project financing have opened wider – with non-bank lenders marching through with various debt offerings. The current landscape is one where many medium-sized developers are keen to grow, and where large developers are bringing struggling smaller groups under their wing. These two separate trends have themselves bred a market in which non-bank lenders can compete.
Potentially problematic to China’s financial ecosystem is the increasing proliferation of development loans, mezzanine debt and non-performing loans. While these serve as a convenient channel through which smaller and medium sized companies can access financing as well as providing additional choices for investors steering away from equity, they are characterized by higher credit risk. There is a common thread that runs through both the Indian and the Chinese stories – the rise of non-performing loans. Unfolding against a backdrop of heightening leverage, this has cast a shadow on developers’ credit risk.
Elsewhere in Asia Pacific – especially so in Australia and Hong Kong, we now see mezzanine financing by non-bank lenders such as private funds increasingly being used in commercial property transactions. The utilization of mezzanine debt can, to an extent, reconcile the tradeoffs when committing to a single debt or equity approach. Along with preferred equity, mezzanine financing is now overtaking senior debt in the traditional composition of real estate capital – largely due to the limited debt offerings by senior lenders.
With risk comes opportunity, though. The availability of a broad spectrum of debt instruments offers greater investor choice, provides a match for varying levels of risk appetite and ultimately enhances a country’s financial ecosystem. optimization of real estate debt investments can occur when there is a strengthening of default provisions, robust due diligence frameworks and proper leveraging of investors’ knowledge surrounding the assets in which they invest and the structure of related transactions.
The suitability of debt offerings by non-bank lenders to finance real estate transactions across Asia Pacific will hinge on many things. Not all investments will have scorecards of positive cash flows and prime credit ratings hovering above. Thus, adequate packaging of the conditions attached to a loan must be paired with a rigorous assessment of credit risk. The macro variables cannot be omitted from the equation, either, it always pays to be aware of your surroundings.
By Yvonne Siew, Executive Director, Global Capital Markets.