Chinese property developers recently missed payments on wealth management products and corporate bonds, which compete for the title of China’s riskiest assets. Major promoters raised funds through all available channels to maintain cash flow. Principal and interest from investment income frequently came from property sales, which have declined sharply this year. As a result, wealth management products and corporate bonds both reveal their risks, as a receding tide reveals beached boats.
While corporate bonds are generally not considered shadow banking and wealth management products are, both have experienced fragility and defaults in recent months than other assets, such as stocks, did not have to endure to the same extent. This has been most evident in the real estate sector, which has acted as a major engine of growth in the slowing Chinese 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 flow.
Despite the regulations imposed in recent years on wealth management products, these products remain risky, especially those issued by real estate companies. As regulation tended to target bank-issued products, real estate developers expanded their portfolios of off-balance sheet debt 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 stay afloat. This pressure has led to credit downgrades and a fall in the value of stocks and bonds as investors fear the company will be increasingly unable to service its short-term debt. The company is working on an investor reimbursement plan.
Kaisa is not alone. Indebted, Evergrande faced protests in September over its failure to repay wealth management products. The company owes about $6 billion in proceeds and expects to pay off its debts by 2023, but some investors remain skeptical. A unit of Oceanwide Holdings, Minsheng Wealth Management, also missed reimbursements for wealth management products. 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 re-issue such products to pay off existing debt. Local over-the-counter exchanges were banned earlier this year from issuing wealth management products using real estate as the underlying asset.
Property developers are no better off in the corporate bond market. The market was already in turmoil due to increased bond failures in the offshore bond market, and the decline of real estate developers such as Evergrande and Kaisa only made matters worse. During the first three quarters of the year, non-financial corporate bond defaults amounted to $15.5 billion. Developers such as Fantasia Group Holdings, Modern Land (China) and Sinic Holdings Group have by default on their offshore obligations. Evergrande narrowly missed the default by making payments just before the default deadline.
Yields on Chinese corporate bonds have hit record highs in a decade. Render on a ICE BofA Index Chinese junk bonds rose more than 26% in early November, signaling elevated default risks. The index has lost 28% in 2021 so far. Real estate bonds represent the majority of China’s corporate bond market.
In contrast, returns from wealth management products are not as high. Most products are priced between 3-6%. Evergrande sold wealth management products with a high yield of 12%, but even this interest rate does not reflect the high level of risk associated with these products, compared to the corporate bond market. Unlike corporate bonds, the price of the asset does not fluctuate.
To complicate the situation, wealth management products often contain corporate bonds as the underlying securities. New rules issued in June this year stated that cash management products could not invest in junk bonds or long-term debt, and that the products had to be compliant by the end of 2022. this time, $390.5 billion of cash management products were to become non-compliant. Until compliance is achieved, potential contagion effects from the corporate bond market are likely to create fragility in the wealth management products market as well.
Over the next year, $507 billion in weak onshore corporate debt is expected mature, while $58 billion of weak offshore corporate debt will come due. The total amount of wealth management products outstanding was $4.4 trillion as of September 30, 2021; real estate companies have missed payments or restructured payment terms on $8 billion of such products as of November 10.
Debt held in mainland China appears to be prioritized for repayment, most likely to quell domestic unrest. However, the two types of products sold by the real estate sector, corporate bonds and wealth management products, appear to carry extremely high risks amidst uncertainty.