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Chinese developer bond risk rises to a record

(HONG KONG) The risk of Chinese real estate developers defaulting on their debt soared to a record on concern they will seek to sell securities after Country Garden Holdings Co completed its first convertible bond sale.

Three-year credit-default swaps on Country Garden traded at 1,100 basis points at 4:27pm in Hong Kong, according to BNP Paribas SA prices. Five-year contracts on Shimao Property Holdings Ltd rose 75 basis points to 975 basis points while swaps on Agile Property Holdings also increased 75 basis points to 1,000 basis points. A basis point is 0.01 percentage point.

The first public bond sale by a Chinese real estate developer since November showed investors are becoming more confident in the long-term outlook of the sector’s biggest companies. House prices in China shrugged off government curbs on lending to rise 10.5 per cent in December from a year earlier, maintaining the fastest pace since records began in 2005.

‘It’s generally a good thing for Country Garden to be able to raise the funds, but the deal also opens the gate for other debt fund-raising from Chinese real estate companies,’ said Arthur Lau of JF Asset Management Ltd in Hong Kong, who helps manage US$128 billion of assets. ‘People are worried that bond sales will scramble to come to the market, not just from Country Garden but also from other developers.’

Country Garden’s share price jumped as much as 15 per cent yesterday. The stock closed up 12 per cent at HK$7.48 in Hong Kong.

Country Garden, China’s most profitable property developer, last week raised 3.6 billion yuan (S$709.3 million) selling convertible debt maturing in 2013. Investors can hand over the bonds for Country Garden’s shares at HK$9.05 apiece, which is 37 per cent more than the average price as weighted by volume on Feb 15, according to an e-mail sent to investors.

Country Garden’s 2.5 per cent convertible bonds now trade at 104.15 per cent the face value, according to Nomura Holdings Inc prices. Country Garden’s debt is rated the lowest investment grade at BBB- by

Standard & Poor’s. Moody’s Investors Service ranks it one step lower at Ba1.

Credit-default swaps on Greentown China Holdings Ltd rose 50 basis points to 1,175 basis points.

Contracts on Hopson Development Holdings Ltd jumped 50 to 1,250 basis points, according to BNP Paribas. That means it costs US$1.25 million a year to protect US$10 million of Hopson’s debt from default for five years. It implies a more than 65 per cent chance of default in the next five years, according to a valuation model by JPMorgan Chase & Co.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

New bond sales increase the risk of default as they add more debt to the companies.

The credit risk of Chinese real estate developers has exceeded that of their troubled peers in the United

States on concern that China’s government will announce new measures to more effectively rein in rising property prices, and that developers will need to sell more debt to fund expansion or risk losing market share to rivals.

High-yield bonds of US home builders hurt by the sub-prime loan crisis now trade at an average 10.55 percentage points more than US Treasuries, according to a Merrill Lynch & Co index that tracks 93 securities. Greentown’s 9 per cent US$400 million bonds maturing in 2013 trade at a record 12.56 percentage points above US government bonds, up 64 basis points from Friday, according to ING Groep NV prices. Hopson’s 8.125 per cent US$350 million securities due in 2012 widened 90 basis points to a record 12.78 percentage points over US Treasuries.

Investors should price in more risk on the bonds of Chinese property developers to reflect the weak structures of the deals and the untested legal system for defaults in China, analysts led by Hong Kong based Pradeep Mohinani at Lehman Brothers Holdings Inc said in a research note on Feb 15.

‘We reiterate a more defensive investment strategy and recommend investors to avoid this highly volatile sector in the near term because of rising industry and supply risks,’ the Lehman analysts wrote in the report.

Bonds of Chinese developers should trade at between 150 to 180 basis points more than their US peers,

the analysts said.

Source: Bloomberg (Business Times 19 Feb 08)

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