The country's housing market will face a crisis unless Beijing steps in with a large-scale rescue, as investors are pricing in losses on Chinese property developers' dollar debt.
A common threshold for distressed status is that two-thirds of the bonds issued by Chinese developers are priced below 70 cents on the dollar.
Evergrande, the world's most indebted developer, began to spiral into default a year ago, unleashing tumult throughout the sector that accounts for 30 per cent of the country's annual economic output.
Beijing reduced the mortgage lending rate this week. If policymakers don't launch a sweeping rescue of the industry, it will only add to the cost of saving the industry and will make it harder for global markets and trade.
Many more developers have seen their dollar bond prices fall since last year, according to a senior credit analyst. For developers with large offshore debt maturities and weak sales, we think defaults will continue through the rest of the year.
A lot of developer dollar bonds are now priced at a high risk of default. Kaisa Group, one of the first in the sector to miss a dollar payment late last year, has a bond maturing on September 7 that is priced at $0.09 on the dollar, implying a loss of about $272 million. A bond of the same size from Shanghai-based Shimao maturing in just over a year is priced just below $0.10 on the dollar.
Chinese real estate groups owe more than $200 billion in dollar bond repayments, and investors have priced in almost $130 billion of losses, reflecting a discount of nearly two-thirds to the market's presumed value if all repayments were successful.
The Chinese real estate groups missed payments on a record amount of bonds. The companies have had to contend with maturity walls, in which several developers are expected to pay back principal at the same time. Ructions in the market have made it nearly impossible for issuers to roll over borrowings into new debt.
A veteran investment banker in Hong Kong described the situation as a "perfect storm" for developers, who must try to refinance to stave off more missed payments while struggling to soothe growing doubts among Chinese home buyers.
The head of debt syndicate for Asia at a European lender said that the bonds are trading at distressed levels. It is anyone's guess as to how many of these guys will repay.
The worst of the pressure was supposed to be limited to the most debt-laden groups, such as Evergrande, which had grown more reliant on presales of unfinished housing in recent years.
Fears among the general public that other groups might go bust before finishing pre-sold homes are heightened by the fact that construction on projects at Evergrande and a few high-risk developers has stopped. Large swaths of the industry have been thrown into a liquidity crunch as a result of the crisis of confidence caused by that.
Robin Xing, chief China economist at Morgan Stanley, thinks that a more centralised bail out is necessary for the country's housing market.
The problem of financing unfinished housing projects would become worse the longer policymakers waited to act, according to Xing. If you don't support the downward spiral, the gap could expand in six months.
Hundreds of thousands of buyers across China have joined a nationwide boycott of mortgage payments due to widespread work halts on pre-sold homes.
The situation is out of control according to Rosealea Yao, a property market analyst. No one anticipated what we are seeing today with mortgage boycotts and construction suspension. We could be in worse shape a year from now.
Home sales in China fell in the first half of the year, according to official figures. Andy Suen, portfolio manager and head of Asia ex-Japan credit research at PineBridge Investments in Hong Kong, said policy support for the sector has not been enough in stabilizing the property market.
Weakest names in the sector have already default and now the problem is spreading to the higher quality ones.
State-run Chinese investment banks have tried to sell holdings of developers' dollar debt, but staff at the banks' international arms said they have struggled to get approval from Beijing. The product manager at the state bank in Hong Kong said that the bonds crashed further when the approval arrived.
The crashes have left most of the Chinese real estate groups frozen out of the international bond market, further limiting their ability to refinance and increase their risk of default. The amount of dollar bonds issued by developers has fallen 80% so far this year to just $7.2 billion, which is the lowest level of sales in a decade.
There is little hope among analysts for a rebound in sales this year that could help spare foreign bondholders from further defaults.
There will be a 15 per cent fall in annual property sales this year and a 33 per cent drop in construction starts if policymakers don't resolve the issue of pre-sold homes
All these households can get a house if the government shows that at the end of the day. It will be very damaging if they can't do that.
Policymakers have been hesitant to discuss the scale or timing of any rescue, although the central bank, housing regulator and finance ministry have pledged to offer special loans to ensure property projects are delivered to buyers.
In the case of a surprise cut to China's mortgage lending rate made this week, investors said the measures were unable to restore confidence in pre-sold housing.
A veteran fixed-income investor in Hong Kong thinks policymakers don't realize it's not enough. There needs to be some big bazooka action to improve sentiment.
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