Kaisa Hidden Hands Means 10% Threshold for Junk-Rated Builders

The woes of Kaisa Group Holdings Ltd. show investors will demand yields of at least 10 percent to buy Chinese real-estate junk bonds amid growing wariness of state interference in the property market.

Rates on dollar-denominated debt sold by the nations developers rose to 13.03 percent on average yesterday, a Bank of America Merrill Lynch index shows. That compares with 8.94 percent six months ago. Some 41 builders paid an average 8.48 percent to raise $18 billion of dollar bonds in 2014, Bloomberg-compiled data shows.

Kaisa declined to say today whether it has made a $25.625 million coupon payment, due yesterday, on $500 million of 10.25 percent 2020 notes. The semi-annual coupon falls on Jan. 8 and July 8 every year, according to data compiled by Bloomberg. The builder defaulted on a bank loan on Dec. 31, after its chairman quit and projects in its home city of Shenzhen were blocked by authorities without explanation.

As long as the uncertainty is there, the market will find it hard to price bonds according to their intrinsic value, Peter Jeggli, a money manager and head of credit research at Fisch Asset Management AG in Zurich, said in an interview yesterday. If things get worse, better quality names probably need to see 10 percent yields before investors step in. Fisch Asset manages $8.5 billion of notes.

Kaisas $500 million of 2020 securities were sold to investors at par, or 100 cents on the dollar, in January 2013. They touched a record-low 29.901 cents on Jan. 7 and are rising in trade today.

I got very scared of corporate governance in the property sector, said Jeggli, citing the hidden hands behind recent management upheavals in cases like Kaisa and Agile Property Holding Ltd. Jeggli sold his Kaisa notes last quarter.

Recent events have underscored the need to price in a higher risk premium for Asian, particularly Chinese, high-yield bonds, according to Brigitte Posch, the London-based head of emerging market corporate debt at Babson Capital Management LLC. Political risk factors should no longer be relegated to background noise, she said.

The restrictions on Kaisas Shenzhen assets by the local government without official notification of a reason would be illegal in most developed markets, Posch said by e-mail today. The market has now had two developers affected by investigations, which suggests that perhaps the risk premium being priced into that specific sector was previously too low.

Speculative-grade Chinese notes are off to their worst start to a year on record and more developers may be at risk. Logan Property Holdings Co.s 11.25 percent notes due 2019 tumbled 23.7 cents in the five days through yesterday to a record-low 75 cents. Some of its projects were also blocked.

Regardless of whether the Kaisa coupon gets paid or not, the damage is already done, said Michel Lowy, chief executive officer at Hong Kong-based SC Lowy Financial (HK) Ltd., an independent bond and loan trading firm. Clearly, external factors that cant be analyzed may interfere with recoveries or value of Chinese bonds, and this will need to be priced in.

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Kaisa Hidden Hands Means 10% Threshold for Junk-Rated Builders