Perpetual securities are corporate bonds with high interest rates and no maturity date. That means issuers have to continue to make interest payments on the bonds if they can't redeem them.
They are increasingly popular among Chinese property developers hit by the country's real-estate slump and government limits on their ability to tap credit from state-controlled banks. Among their advantages to issuers, they can be treated on the balance sheet as equity, or a hybrid of equity and debt, rather than debt. That is because the payments are made at the discretion of the company, so they are considered dividends rather than interest payments.
Some analysts said using the securities helped make the results of some property companies look better than they really were. "Beneath the looks-to-be good gearing in the first-half results, we note more developers have reported issuance of perpetual securities," said Citi Research analysts Oscar Choi and Marco Sze in a note. "We regard these instruments as 'toxic' for investors, as they can mask true real leverage and profitability through accounting moves." Gearing, or leverage, compares net debt to equity.
As of June, eight listed property developers had issued perpetual securities totaling 86.5 billion yuan ($14.1 billion), nearly double the 44.1 billion yuan recorded in the whole of 2013, Citi said. "If we reclassify their perpetuals as debt rather than equity, gearing would sharply escalate," Citi said.
One issuer was Hong Kong-traded Beijing Capital Land Ltd., whose subsidiary last year sold $400 million in perpetual securities that pay dividends at an annual rate of 8.375%. It said the securities give it flexibility in terms of interest rates and the payment of principal, allowing the firm to make extensions depending on its financial position.
"We have more flexibility in the usage of funds raised from such securities, which have longer tenors.
While bank loans typically have tenors that are two to three years, it's actually much shorter because there are repayment requirements hinged on property sales," said a spokesman from the midsize
developer.
He said that the perpetual securities it issued had favorable interest rates compared with its peers, but didn't provide further details. He declined to comment on Citi Research's remarks.
Three other companies cited by Citi— Evergrande Real Estate Group Ltd., Guangzhou R&F Properties Co. and Agile Property Holdings Ltd.—declined to comment. The others— Sino Ocean Land Holdings Ltd., Franshion Properties (China) Ltd., Kaisa Group Holdings Ltd. and CIFI Holdings (Group) Co. —didn't respond to requests for comment.
Jefferies analyst Venant Chiang said such perpetual securities have worsened developers' financial positions. In his analysis of 18 property developers in the first half, when he reclassified perpetual securities as debt instead of equity, their average ratio of debt to equity hit a high of 83% compared with 61% as of the end of last year.
Chinese property developers have been facing tighter credit conditions since 2010, and the industry faces falling sales amid this year's property slump. Restrictions on the use of bank loans have compelled many to seek alternative financing.
"If companies are not able to fund themselves using more established channels such as construction loans, they would seek alternatives, which come at a steep price," said Christopher Lee, a managing director at Standard & Poor's Ratings Services.
Depending on how they are structured,analysts view the perpetual bonds as equity, a hybrid of equity and debt, or simply as debt. Most of them have interest rates from 9% to 12% in first two to three years, which jump to as high as 20% from the fourth year if the bonds aren't redeemed by then, according to analysts and ratings firms such as Moody's Investors Service and Standard & Poor's.
"They feel that the cost is reasonable and are confident of using property sales proceeds to repay the perpetuals before maturity," said Franco Leung, a vice president at Moody's.
Among the developers, analysts highlighted Guangzhou-based developer Evergrande as relying most heavily on perpetual securities. Evergrande's leverage would jump to 248% from 90% if the securities were classified as debt, Citi Research says.
Evergrande has said it issued perpetual bonds on individual projects amounting to 17.58 billion yuan ($2.86 billion) in new financing in the first half this year.
Leverage for Guangzhou R&F, another property developer, would rise to 186% from 92%, according to Citi. For Agile Property, the ratio would rise to 107% from 82%.
Source: Wall Street Journal by Esther Fung
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