Chinese real estate developers have recently missed payments on wealth management products and corporate bonds, which are competing with one another for the title of China’s riskiest assets. Major developers raised funds from all available channels in order to maintain cash flows. Investment products’ principal and interest frequently came from property sales, which have greatly declined this year. As a result, both wealth management products and corporate bonds are both revealing their risks, as a falling tide reveals stranded boats.
While corporate bonds are generally not considered part of the shadow banking sector and wealth management products are, both have experienced fragility and failures in recent months that other assets, such as stock shares, have not had to endure to the same extent. This has been most apparent in the real estate sector, which has acted as a major engine of growth in China’s slowing economy. With the introduction of the “three red lines” policy, which required property developers to shore up their balance sheets, companies scrambled to clean up their financial statements and maintain cash flows.
Despite regulations imposed on wealth management products in recent years, such products remain risky, especially those issued by real estate companies. While regulations tended to target products issued by banks, property developers expanded their off-balance sheet debt holdings by selling these securities. Now they are struggling to repay them.
Kaisa Group Holdings recently missed $2 billion in principal and interest payments on wealth management products due to its ongoing struggle to remain afloat. This pressure has resulted in credit downgrades and tumbling stock shares and bond values, as investors fear that the company is increasingly unable to service short-term debt. The company is working on a plan to repay investors.
Kaisa is not alone. Debt-mired Evergrande faced protests in September due to its failure to repay wealth management products. The company owes about $6 billion in the products and has plans to repay its liabilities by 2023, but some investors remain skeptical. A unit of Oceanwide Holdings, Minsheng Wealth Management, also missed wealth management product repayments The company is already behind on its repayment plan.
Chinese regulators had frozen the issuance of asset-backed securities by property developers for three months, starting in August. Developers will soon be allowed to issue such products once again in order to repay existing debt. Local OTC exchanges were banned earlier this year from issuing wealth management products using real estate as an underlying asset.
Property developers are faring no better in the corporate bond market. The market was already in turmoil due to increasing bond failures in the offshore bond market, and the decline of real estate developers such as Evergrande and Kaisa only worsened the situation. In the first three quarters of the year, non-financial corporate bond defaults amounted to $15.5 billion. Developers including Fantasia Group Holdings, Modern Land (China), and Sinic Holdings Group have defaulted on their offshore bonds. Evergrande narrowly missed default by making payments just before the default deadline.
Returns on Chinese corporate bonds have soared to decade-high levels. Yields on an ICE BofA index of Chinese junk bonds rose over 26 percent in early November, signaling high default risks. The index has lost 28 percent in 2021 so far. Real estate bonds comprise the majority of the Chinese corporate bond market.
By contrast, wealth management product yields do not trend as high. Most products are priced between 3 percent and 6 percent. Evergrande sold wealth management products yielding a hefty 12 percent, but even this interest rate does not reflect the high level of risk associated with these products, as compared to the corporate bond market. Unlike in the case of corporate bonds, the asset price does not fluctuate.
To make the situation more complicated, wealth management products often contain corporate bonds as underlying securities. New rules issued in June of this year stated that cash management products may not invest in junk bonds or long-term debt, and products must be compliant by the end of 2022. At that time, $390.5 billion in cash management products were expected to become non-compliant. Until compliance is reached, potential contagion effects from the corporate bond market are likely to create fragility in the wealth management product market as well.
In the next year, $507 billion in weak onshore corporate debt is expected to mature, while $58 billion in weak offshore corporate debt will mature. The total amount of wealth management products outstanding was $4.4 trillion as of September 30, 2021; real estate companies missed payments or restructure payment terms on $8 billion worth of such products as of November 10.
Debt that is held within mainland China appears to be prioritized in terms of repayment, most likely in order to quell domestic unrest. Still, both types of products sold by the property sector, corporate bonds and wealth management products, appear to come with extremely high risks as uncertainty prevails.