takeover of Twitter Inc. plan to hold all $13 billion of debt backing the deal rather than syndicate it out, according to people familiar with the matter, in another blow to a market that serves as a crucial source of corporate funding.
Twitter could have the dubious distinction of being the biggest so-called hung deal of all time, surpassing a crop of them in the global financial crisis, when banks were stuck with around $300 billion of committed debt they struggled to sell to investors.
Twitter will become a private company if Elon Musk’s $44 billion takeover bid is approved. The move would allow Musk to make changes to the site. WSJ’s Dan Gallagher explains Musk’s proposed changes and the challenges he might face enacting them. Illustration: Jordan Kranse
The Twitter move threatens to bring the faltering leveraged-buyout pipeline to a standstill by tying up capital that Wall Street could otherwise use to back new deals.
The $44 billion Twitter takeover is backed by banks including Morgan Stanley,
Bank of America Corp.
and Barclays PLC, which signed agreements in April to provide Mr. Musk with the debt financing he needed to buy the company. They had originally intended to find third-party investors, such as loan asset managers and mutual funds, who would ultimately lend the money as is customary in leveraged buyouts.
But rising interest rates and growing concerns about a recession have cooled investors’ appetite for risky loans and bonds. Mr. Musk’s past criticism of Twitter’s alleged misrepresentation of the condition of its business and the number of fake accounts on the platform aren’t helping either—nor is a deterioration in Twitter’s business, the people added.
Banks would likely face losses of around $500 million or more if they tried to sell Twitter’s debt at current market prices, The Wall Street Journal previously reported. If all the banks hold the debt instead, they can mark it at a higher value on their books on the premise that prices will eventually rebound.
Banks also face a timing problem: Mr. Musk and Twitter have until Oct. 28 to close his planned purchase, and there is still no guarantee the unpredictable billionaire will follow through or some other trouble won’t arise. (If the deal doesn’t close by that time, the two parties will go to court in November.) That means the banks wouldn’t have enough time to market the debt to third-party investors, a process that normally takes weeks, even if they wanted to sell it now.
Assuming the deal closes, banks hope to be able to sell some of Twitter’s debt by early next year, should market conditions improve by then, some of the people said. Twitter’s banks are discussing how to potentially slice up the debt into different pieces that could be easier for hedge-fund investors or direct lenders to swallow, one of these people said.
The banks have good reason to want to hold the debt for as short a time period as possible.
Holding loans and bonds can force them to set more capital aside to meet regulatory requirements, limiting the credit banks are able to provide to others. Banks also face year-end stress tests, and they will want to limit their exposure to risky corporate debts before regulators evaluate the soundness of their balance sheets.
So far this year, banks have already taken hundreds of millions of dollars worth of losses and been forced to hold a growing amount of buyout debt.
Twitter’s debt, including $6.5 billion of term loans and $6 billion of bonds, would add to the increasing pile banks eventually intend to syndicate, recently estimated by
Goldman Sachs
at around $45 billion.
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Major news in the world of deals and deal-makers.
Banks’ third-quarter earnings showed a steep drop-off in revenue tied to deal-making. Goldman’s debt-underwriting revenue dropped to $328 million in the third quarter from $726 million a year earlier.
Morgan Stanley CEO
James Gorman
said recently that his bank has been “quite cautious in the leveraged-finance arena” for new deals, while Bank of America’s
Brian Moynihan
said “there’s been a natural retrenching” in the leveraged-loan market and the bank “was working to get through the pipeline” of existing deals.
Private-equity firms, which rely heavily on debt to fund their buyouts, have increasingly turned to private-credit providers such as Blackstone Credit and
Blue Owl Capital Inc.
These firms don’t have to split up and sell debt and can provide funding from investment vehicles established to do so. Although it is more expensive and harder to come by than earlier this year, private-credit providers have been the main source of buyout financing recently.
To deal with debts they have already committed to, banks have gotten increasingly creative.
In a take-private of Citrix Systems Inc., banks agreed to turn some $6 billion of syndicated term loans into a more traditional bank loan that they chose to keep on their balance sheets, but they sold around $8 billion of bonds and loans at a loss of more than $500 million, the Journal reported. There was also a revision in the financing structure of the Nielsen Holdings PLC take-private, with $3 billion in unsecured bonds becoming a junior secured loan that private-credit provider
Ares Capital Corp.
agreed to lead. The banks held the remainder of Nielsen’s roughly $9 billion of debt on their balance sheets.
—Matt Wirz contributed to this article.
Write to Laura Cooper at laura.cooper@wsj.com and Alexander Saeedy at alexander.saeedy@wsj.com
are facing the possibility of big losses now that the billionaire has shifted course and indicated a willingness to follow through with the deal, in the latest sign of trouble for debt markets that are crucial for funding takeovers.
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Major news in the world of deals and deal-makers.
As is typical in leveraged buyouts, the banks planned to unload the debt rather than hold it on their books, but a decline in markets since April means that if they did so now they would be on the hook for losses that could run into the hundreds of millions, according to people familiar with the matter.
Banks are presently looking at an estimated $500 million in losses if they tried to unload all the debt to third-party investors, according to 9fin, a leveraged-finance analytics firm.
Representatives of Mr. Musk and Twitter had been trying to hash out terms of a settlement that would enable the stalled deal to proceed, grappling with issues including whether it would be contingent on Mr. Musk receiving the necessary debt financing, as he is now requesting. On Thursday, a judge put an impending trial over the deal on hold, effectively ending those talks and giving Mr. Musk until Oct. 28 to close the transaction.
The debt package includes $6.5 billion in term loans, a $500 million revolving line of credit, $3 billion in secured bonds and $3 billion in unsecured bonds, according to public disclosures. To pay for the deal, Mr. Musk also needs to come up with roughly $34 billion in equity. To help with that, he received commitment letters in May for over $7 billion in financing from 19 investors including
Oracle Corp.
co-founder and
Tesla Inc.
then-board member
Larry Ellison
and venture firm Sequoia Capital Fund LP.
Twitter will become a private company if Elon Musk’s $44 billion takeover bid is approved. The move would allow Musk to make changes to the site. WSJ’s Dan Gallagher explains Musk’s proposed changes and the challenges he might face enacting them. Illustration: Jordan Kranse
The Twitter debt would be the latest to hit the market while high-yield credit is effectively unavailable to many borrowers, as buyers of corporate debt are demanding better terms and bargain prices over concerns about an economic slowdown.
That has dealt a significant blow to a business that represents an important source of revenue for Wall Street banks and has already suffered more than $1 billion in collective losses this year.
The biggest chunk of that came last month, when banks including Bank of America,
Goldman Sachs Group Inc.
and
Credit Suisse Group AG
sold debt associated with the $16.5 billion leveraged buyout of Citrix Systems Inc. Banks collectively lost more than $500 million on the purchase, the Journal reported.
Banks had to buy around $6 billion of Citrix’s debt themselves after it became clear that investors’ interest in the total debt package was muted.
“The recent Citrix deal suggests the market would struggle to digest the billions of loans and bonds contemplated by the original Twitter financing plan,” said Steven Hunter, chief executive at 9fin.
People familiar with Twitter’s debt-financing package said the banks built “flex” into the deal, which can help them reduce their losses. It enables them to raise the interest rates on the debt, meaning the company would be on the hook for higher interest costs, to try to attract more investors to buy it.
However, that flex is usually capped, and if investors still aren’t interested in the debt at higher interest rates, banks could eventually have to sell at a discount and absorb losses, or choose to hold the borrowings on their books.
Elon Musk has offered to close his acquisition of Twitter on the terms he originally agreed to.
Photo:
Mike Blake/REUTERS
The leveraged loans and bonds for Twitter are part of $46 billion of debt still waiting to be split up and sold by banks for buyout deals, according to Goldman data. That includes debt associated with deals including the roughly $16 billion purchase of
Nielsen Holdings
PLC, the $7 billion acquisition of automotive-products company
Tenneco
and the $8.6 billion takeover of media company
Tegna Inc.
Private-equity firms rely on leveraged loans and high-yield bonds to help pay for their largest deals. Banks generally parcel out leveraged loans to institutional investors such as mutual funds and collateralized-loan-obligation managers.
When banks can’t sell debt, that usually winds up costing them even if they choose not to sell at a loss. Holding loans and bonds can force them to add more regulatory capital to protect their balance sheets and limit the credit banks are willing to provide to others.
In past downturns, losses from leveraged finance have led to layoffs, and banks took years to rebuild their high-yield departments. Leveraged-loan and high-yield-bond volumes plummeted after the 2008 financial crisis as banks weren’t willing to add on more risk.
Indeed, many of Wall Street’s major banks are expected to trim the ranks of their leveraged-finance groups in the coming months, according to people familiar with the matter.
Still, experts say that banks look much better positioned to weather a downturn now, thanks to postcrisis regulations requiring more capital on balance sheets and better liquidity.
“Overall, the level of risk within the banking system now is just not the same as it was pre-financial crisis,” said Greg Hertrich, head of U.S. depository strategy at Nomura.
Last year was a banner year for private-equity deal making, with some $146 billion of loans issued for buyouts—the most since 2007.
However, continued losses from deals such as Citrix and potentially Twitter may continue to cool bank lending for M&A, as well as for companies that have low credit ratings in general.
“There’s going to be a period of risk aversion as the industry thinks through what are acceptable terms for new deals,” said Richard Ramsden, an analyst at Goldman covering the banking industry. “Until there’s clarity over that, there won’t be many new debt commitments.”
—Cara Lombardo contributed to this article.
Write to Alexander Saeedy at alexander.saeedy@wsj.com, Laura Cooper at laura.cooper@wsj.com and Ben Dummett at ben.dummett@wsj.com
Federal Reserve Chairman Jerome Powell fired a warning shot across Wall Street last week, telling investors the time has come for financial markets to stand on their own feet, while he works to tame inflation.
The policy update last Wednesday laid the ground work for the first benchmark interest rate hike since 2018, probably in mid-March, and the eventual end of the central bank’s easy-money stance two years since the onset of the pandemic.
The problem is that the Fed strategy also gave investors about six weeks to brood over how sharply interest rates could climb in 2022, and how dramatically its balance sheet might shrink, as the Fed pulls levers to cool inflation which is at levels last seen in the early 1980s.
Instead of soothing market jitters, the wait-and-see approach has Wall Street’s “fear gauge,” the Cboe Volatility Index
VIX,
-9.28%,
up a record 73% in the first 19 trading days of the year, according to Dow Jones Market Data Average, based on all available data going back to 1990.
“What investors don’t like is uncertainty,” said Jason Draho, head of asset allocation Americas at UBS Global Wealth Management, in a phone interview, pointing to a selloff that’s left few corners of financial markets unscathed in January.
Even with a sharp rally late Friday, the interest rate-sensitive Nasdaq Composite Index
COMP,
+3.13%
remained in correction territory, defined as a fall of at least 10% from its most recent record close. Worse, the Russell 2000 index of small-capitalization stocks
RUT,
+1.93%
is in a bear market, down at least 20% from its Nov. 8 peak.
“Valuations across all asset classes were stretched,” said John McClain, portfolio manager for high yield and corporate credit strategies at Brandywine Global Investment Management. “That’s why there has been nowhere to hide.”
McClain pointed to negative performance nipping away at U.S. investment-grade corporate bonds
LQD,
+0.11%,
their high-yield
HYG,
+0.28%
counterparts and fixed-income
AGG,
+0.07%
generally to begin the year, but also the deeper rout in growth and value stocks, and losses in international
EEM,
+0.49%
investments.
“Every one is in the red.”
Wait-and-see
Powell said Wednesday the central bank “is of a mind” to raise interest rates in March. Decisions on how to significantly reduce its near $9 trillion balance sheet will come later, and hinge on economic data.
“We believe that by April, we are going to start to see a rollover on inflation,” McClain said by phone, pointing to base effects, or price distortions common during the pandemic that make yearly comparison tricky. “That will provide ground cover for the Fed to take a data-dependent approach.”
“But from now until then, it’s going to be a lot of volatility.”
‘Peak panic’ about hikes
Because Powell didn’t outright reject the idea of hiking rates in 50-basis-point increments, or a series of increases at successive meetings, Wall Street has skewed toward pricing in a more aggressive monetary policy path than many expected only a few weeks ago.
The CME Group’s FedWatch Tool on Friday put a near 33% chance on the fed-funds rate target climbing to the 1.25% to 1.50% range by the Fed’s December meeting, through the ultimate path above near- zero isn’t set in stone.
Read: Fed seen as hiking interest rates seven times in 2022, or once at every meeting, BofA says
“It’s a bidding war for who can predict the most rate hikes,” Kathy Jones, chief fixed income strategist at Schwab Center for Financial Research, told MarketWatch. “I think we are reaching peak panic about Fed rate hikes.”
“We have three rate hikes penciled in, then it depends on how quickly they decide to use the balance sheet to tighten,” Jones said. The Schwab team pegged July as a starting point for a roughly $500 billion yearly draw down of the Fed’s holdings in 2022, with a $1 trillion reduction an outside possibility.
“There’s a lot of short-term paper on the Fed’s balance sheet, so they could roll off a lot really quickly, if they wanted to,” Jones said.
Time to play safe?
““You have the largest provider of liquidity to markets letting up on the gas, and quickly moving to tapping the brakes. Why increase risk right now?””
— Dominic Nolan, chief executive officer at Pacific Asset Management
It’s easy to see why some beaten down assets finally might end up on shopping lists. Although, tighter policy hasn’t even fully kicked in, some sectors that ascended to dizzying heights helped by extreme Fed support during the pandemic haven’t been holding up well.
“It has to run its course,” Jones said, noting that it often takes “ringing out the last pockets” of froth before markets find the bottom.
Cryptocurrencies
BTCUSD,
-0.78%
have been a notable casualty in January, along with giddiness around “blank-check,” or special-purpose acquisition corporations (SPACs), with at least three planned IPOs shelved this week.
“You have the largest provider of liquidity to markets letting up on the gas, and quickly moving to tapping the brakes,” said Dominic Nolan, chief executive officer at Pacific Asset Management. “Why increase risk right now?”
Once the Fed is able to provide investors will a more clear road map of tightening, markets should be able to digest constructively relative to today, he said, adding that the 10-year Treasury yield
TMUBMUSD10Y,
1.771%
remains an important indicator. “If the curve flattens substantially as the Fed raises rates, it could push the Fed to more aggressive [tightening] in an effort to steepen the curve.”
Climbing Treasury yields have pushed rates in the U.S. investment-grade corporate bond market near 3%, and the energy-heavy high-yield component closer to 5%.
“High yield at 5%, to me, that’s better for the world than 4%,” Nolan said, adding that corporate earnings still look strong, even if peak levels in the pandemic have passed, and if economic growth moderates from 40-year highs.
Draho at UBS, like others interviewed for this story, views the risk of a recession in the next 12 months as low. He added that while inflation is at 1980s highs, consumer debt levels also are near 40-year lows. “The consumer is in strong shape, and can handle higher interest rates.”
U.S. economic data to watch Monday is the Chicago PMI, which caps the wild month. February kicks off with the Labor Department’s job openings and quits on Tuesday. Then its ADP private sector employment report and homeownership rate Wednesday, following by the big one Friday: the January jobs report.
made an overdue interest payment to international bondholders, the state-owned Securities Times reported Friday, an unexpected move that allows the property company to stave off a default.
The Chinese real-estate developer on Thursday sent $83.5 million to the trustee for the dollar bonds, and that financial institution will in turn pay bondholders, the Securities Times reported. The financial paper is run by the Communist Party’s flagship People’s Daily newspaper.
Evergrande was nearing the end of a 30-day grace period before bondholders could send a notice of default to the company after it failed to make the interest payment on about $2.03 billion of dollar bonds on Sept. 23.
A default on those bonds would likely have spiraled into the biggest corporate default in Asia, by enabling creditors to declare defaults on some of Evergrande’s other debts. The company is one of China’s biggest developers, and its most indebted. It had the equivalent of more than $300 billion in total liabilities, including some $89 billion in interest-bearing debt, as of the end of June.
Many international bondholders had expected Evergrande to fail to make its dollar bond payments before the end of the grace period. The company has also skipped other coupon payments in the past few weeks, and has outstanding dollar debt with a total face value of about $20 billion. Advisers to international bondholders said this month they had made little progress in their efforts to engage with Evergrande.
On Wednesday, however, the Shenzhen-based group said in a regulatory filing that it will “use its best effort to negotiate for the renewal or extension of its borrowings or other alternative arrangements with its creditors.”
Evergrande has been trying to raise funds by disposing of assets such as stakes in subsidiaries and a Hong Kong office building that it owns. Last month, it agreed to sell most of its ownership in a Chinese commercial bank to a state-owned enterprise for the equivalent of $1.55 billion. The company had also planned to sell a majority holding in its property-management unit for the equivalent of about $2.6 billion to a smaller rival, but said this week that it had terminated that deal.
Evergrande’s Hong Kong-listed stock has crashed more than 80% this year and its dollar bonds are trading far below face value, indicating skepticism among investors that they will be repaid in full. On Friday, the shares rose 5% in early trading, while its bonds were still at deeply distressed levels that indicate investors still expect the company to ultimately default.
A $4.7 billion, 8.75% Evergrande bond due 2025 was quoted at just 21.75 cents on the dollar Friday morning in Hong Kong, according to Tradeweb, up from 20.5 cents late Thursday.
The developer is the highest-profile casualty of a campaign by Chinese authorities to tame the housing market, in part by tamping down on excessive corporate borrowing through limits on bank lending and restrictions on developers’ leverage known as the “three red lines.”
But the sector as a whole has run up huge debts—more than $5 trillion, including cash raised from home buyers through presales of still-uncompleted apartments, according to economists at Nomura—and is smarting under the new regime.
Contracted sales, which reflect new contracts signed with home buyers, at many developers fell more than 20% or 30% year-over-year in September, and official government statistics show nationwide new-home prices fell slightly last month for the first time since 2015.
Evergrande’s own contracted sales have plunged even more; the developer said this week that its contracted sales “for the month of September 2021 and up till now” totaled the equivalent of just $572 million, far below the $28.5 billion worth of contracted sales it reported in the full two months of September and October 2020.
Several smaller developers, such as Fantasia Holdings Group Co., have recently either defaulted on their debts or demanded investors wait longer for repayment, and prices for the bonds of many developers are trading at deeply distressed levels.
—Frances Yoon contributed to this article.
China Evergrande Group: Stalled Construction, Massive Debts
Write to Elaine Yu at elaine.yu@wsj.com and Quentin Webb at quentin.webb@wsj.com
As China enters what many economists say is the final stage of one of the largest real-estate booms in history, it is confronting a staggering bill: More than $5 trillion in debt that developers took on when times were good, according to economists at
Nomura Holdings Inc.
That debt is nearly double what it was at the end of 2016 and is more than the entire economic output of Japan, the world’s third-largest economy, last year.
Global markets are braced for a possible wave of defaults, with warning signs flashing over the debt of about two-fifths of development companies that have borrowed from international bond investors.
Chinese leaders are getting serious about addressing the debt, with a series of moves meant to curb excessive borrowing. But doing so without torpedoing the property market, crippling more developers and derailing the country’s economy is quickly turning into one of the biggest economic challenges Chinese leaders have faced in years, and one that could reverberate globally if mismanaged.
Luxury developer
Fantasia Holdings Group Co.
failed to repay $206 million in dollar bonds that matured Oct. 4. In late September, Evergrande, which has more than $300 billion in obligations, missed two interest-payment deadlines for bonds.
Asia’s junk-bond markets suffered a wave of selling last week. On Friday, bonds from 24 of the 59 Chinese development companies in an ICE BofA index of Asian corporate dollar bonds were trading at yields of above 20%, levels that indicate high risk of default.
Some prospective home buyers are balking, forcing the companies to cut prices to raise cash, and potentially accelerating their slide if the trend continues.
The Evergrande Fairyland complex in Lu’An, China, with towers under construction. Evergrande recently missed two bond-interest deadlines.
Photo:
Raul Ariano for The Wall Street Journal
Total sales among China’s 100 largest developers were down by 36% in September from a year earlier, according to data from CRIC, a research unit of property services firm
e-House (China) Enterprise Holdings Ltd.
It showed that the 10 biggest developers, including China Evergrande,
Country Garden Holdings Co.
and
China Vanke Co.
, saw sales down 44% from a year ago.
Economists say that most Chinese developers remain relatively healthy. Beijing also has the firepower and tight control of the financial system needed to prevent a so-called Lehman moment in which a corporate collapse snowballs into a financial crisis, they say.
In late September, The Wall Street Journal reported that China had asked local governments to prepare for problems potentially intensifying at Evergrande.
But many economists, investors and analysts agree that even for healthy ventures, the underlying business model—in which developers use debt to fund a steady churn of new construction despite demographics becoming less favorable for new housing—is likely to change. Some developers might not survive the transition, they say.
Of particular concern is some developers’ practice of relying heavily on “presales,” in which buyers pay in advance for still-uncompleted apartments.
The practice, more common in China than the U.S., means developers are in effect borrowing interest-free from millions of households, making it easier to continue expanding but potentially leaving buyers without finished apartments should the developers fail.
Presales and similar deals were the sector’s biggest funding source this year through August, according to the National Bureau of Statistics of China.
A model of a residential compound by China Vanke, a large developer, at its showroom in Dongguan, China.
Photo:
china stringer network/Reuters
“There is no return to the previous growth model for China’s real-estate market,” said
Houze Song,
a research fellow at the Paulson Institute, a Chicago think tank focused on U.S.-China relations. He said China is likely to keep in place a set of limits on corporate borrowing it imposed last year, known as the “three red lines,” which helped trigger the recent distress at some developers, though he said China might ease some other curbs.
While Beijing has avoided clear public statements on its plans for dealing with the most indebted developers, many economists believe leaders have no choice but to keep the pressure on them.
Policy makers appear determined to revamp a model driven by debt and speculation as part of President
Xi Jinping’s
broader efforts to defuse hidden risks that could destabilize society, especially ahead of important Communist Party meetings next year. Mr. Xi is widely expected then to break with precedent and extend his rule into a third term.
Beijing is worried that after years of rapid home-price gains, some people may be unable to get on the housing ladder, potentially fueling social discontent as wealth gaps widen, economists say. Young couples in large cities are beginning to get priced out, making it harder for them to start families. The median apartment in Beijing or Shenzhen now costs more than 40 times the median family annual disposable income, according to J.P. Morgan Asset Management.
Authorities have said they are worried about the property market posing risks to the financial system. Reining in the developers’ business models and limiting debt, however, is almost certain to slow investment and cause at least some downturn in the property market, which is one of the biggest drivers of China’s growth.
The real-estate and construction industries account for a large part of China’s economy. A 2020 paper by researchers
Kenneth S. Rogoff
and
Yuanchen Yang
estimated that the industries, broadly construed, accounted for 29% of China’s economic activity, far more than in many other countries. Slower growth in housing could spill into other parts of the economy, affecting consumer spending and employment.
Government statistics show about 1.6 million acres of residential floor space was under construction at the end of last year. That was equal to about 21,000 towers with the floor area of the Burj Khalifa in Dubai, the world’s tallest building.
As restrictions on borrowing imposed last year kicked in, housing construction tumbled in August to 13.6% below its pre-pandemic level, calculations by Oxford Economics show.
The revenue local governments earn by selling land to developers fell by 17.5% in August from a year earlier. Local governments, which are also heavily indebted, count on land sales for much of their revenue.
The Luwan 68 development by Fantasia Holdings Group in Shanghai. The luxury developer failed to repay $206 million of dollar bonds that matured on Oct. 4.
Photo:
Qilai Shen/Bloomberg News
A further slowdown also would risk exposing banks to more bad loans. Outstanding property loans—primarily mortgages, but also loans to developers—accounted for 27% of China’s total $28.8 trillion in bank loans at the end of June, according to Moody’s Analytics.
As pressure on housing mounts, several research houses and banks have cut China’s growth outlook. Oxford Economics on Wednesday lowered its forecast for China’s third quarter year-on-year gross domestic product growth to 3.6% from 5% previously. It trimmed its 2022 growth forecast for China to 5.4% from 5.8%.
As recently as the 1990s, most of China’s city residents lived in drab dwellings provided by state-owned employers. When market reforms started transforming the country and more people moved to cities, China needed a massive new supply of higher-quality apartments. Private developers stepped in.
Over the years, they added millions of new units in modern, well-maintained high-rises. In 2019, new homes made up more than three-quarters of home sales in China, versus less than 12% in the U.S., according to data cited by Chinese property broker
KE Holdings Inc.
in a listing prospectus last year.
In the process, the developers became much bigger than anything seen in the U.S. The largest U.S. home builder by revenue,
D.R. Horton Inc.,
reported $21.8 billion of assets at the end of June. Evergrande had some $369 billion. Its assets included vast land reserves and 345,000 unsold parking spaces.
For much of the boom, the developers were filling a need. In more recent years, policy makers and economists began to fret that much of the market was driven by speculation.
Chinese households are restricted from investing abroad, and domestic bank deposits offer low returns. Many people are wary of the country’s boom-and-bust stock markets. So some have poured money into housing, in some cases buying three or four units without any intention of living in them or renting them out.
As developers bought more locations to build on, land sales pumped up national growth statistics. Dozens of entrepreneurs who had founded development companies showed up in lists of Chinese billionaires. Ten of the 16 soccer clubs in the Chinese Super League are wholly or partly owned by developers.
Residential skyscrapers being built in Shanghai, in November 2016.
Photo:
Johannes EISELE/AFP via Getty Images
The real-estate giants have borrowed not only from banks but also from shadow-banking outfits known as trust companies and from individuals who put their savings into investments called wealth-management products. Abroad, they became a mainstay of international junk-bond markets, offering juicy yields to get deals done.
One builder,
Kaisa Group Holdings Ltd.
, defaulted on its debt in 2015, yet was able to keep borrowing and expanding afterward. Two years later it spent the equivalent of $2.1 billion to buy 25 land parcels, and in 2020 spent $7.3 billion for land. This summer, Kaisa sold $200 million of short-term bonds yielding 8.65%.
Nomura estimated that as of June, Chinese developers had racked up debts of $5.2 trillion. It said the biggest share, 46%, was in bank loans. Bond markets accounted for about 10%, including the equivalent of $217 billion of dollar bonds, many of them junk-rated.
By last year, Chinese policy makers had had enough. In August 2020, they introduced the three-red-lines rules limiting how much borrowing developers could do. Some companies with short-term obligations they couldn’t pay without new funding had to start discounting apartments to raise money.
Authorities have tried to curb demand in some places by slowing mortgage lending. They have put caps on existing-home prices in about a dozen cities to tame speculation, according to state media reports.
When old-fashioned funding sources like bank loans grew harder to access, developers became more reliant on presales of unfinished apartments. These made up 26% of the debt in Nomura’s tally.
Presales are often recorded as contract liabilities, an item that shows up on the balance sheets of sector heavyweights such as Evergrande, Country Garden, China Vanke,
Sunac China Holdings Ltd.
and
China Resources Land Ltd.
For these five combined, contract liabilities have jumped 42% in the past three years to the equivalent of $341 billion as of the end of June, FactSet data show.
Developers have also made more use of other liabilities that, like presales, don’t strictly count as debt, such as borrowing more from business partners by taking longer to pay contractors or suppliers.
The construction site of a Vanke residential building in Dalian, China, in 2019.
Photo:
Reuters
Goldman Sachs Group Inc.
analysts recently estimated Evergrande had the equivalent of $156 billion of off-balance-sheet debt and contingent liabilities, including mortgage guarantees to help home buyers get loans.
Share Your Thoughts
Can China cool developers’ borrowing binge without torpedoing the property market and hurting the economy? Join the conversation below.
The other problem for developers, and for China’s property market overall, is the way some of the trends that fueled the boom are reversing.
China’s population is aging. Its workforce has been shrinking since 2012, and official forecasts last year predicted the total population would peak in 2027.
Homeownership is already over 90% for urban households in China, among the highest in the world, according to Mr. Rogoff and Ms. Yang. They cited earlier Chinese research saying that as of late 2018, 87% of home purchases were by buyers who already had at least one dwelling.
Julian Evans-Pritchard,
an economist at Capital Economics, said his firm has looked at developers’ ability to meet their obligations from cash holdings and doesn’t think most are on the brink of default. But, citing changing demographics and reduced internal migration, he said “we’re now at a turning point where actually demand for new urban housing is going to decline over the coming decade. So they’re going to be fighting over a shrinking pie.”
Deng Lin,
a 33-year-old lawyer in Shanghai, planned to sell two properties she owns to buy a bigger one after she gave birth to twins this summer. The government’s clampdown on debt risks derailing her plan of upgrading to a three-bedroom, which she estimates could cost up to $1.86 million.
Tightened mortgage rules means she would have to pay 80% upfront. Banks have been slow to approve her loan application.
“There’s simply too much uncertainty in the market,” she said.
—Anniek Bao contributed to this article.
Write to Quentin Webb at quentin.webb@wsj.com and Stella Yifan Xie at stella.xie@wsj.com
