Friday Failure – Kaisa Bond Default Underlines China Housing Crash

What is Kaisa?

Kaisa Holdings is #1638 on the Hong Kong Stock Exchange and is currently trading at 50% of it's 2014 price at $1.50 per share.  That may make it seem unimportant but, in the Wacky World of Chinese Stocks – it's an $1Bn+ company.  Kaisa specializes in large-scale real estate projects and has borrowed $10.5Bn for various projects but, unfortunately, just went into default for lack of $52M as it also delayed the release of 2014 financials. 

Already the company's $800M worth of 8.875% 2018 bonds have dropped to 55 cents on the Dollar and 2020 notes are no fetching just 29.9% of face value and that's going to look generous as this situation rapidly spirals out of control.  It is estimated that, in a full default, Kaisa's bond-holders can expect about 2 cents on the Dollar because the company has generated no real value for them after spending $10.5Bn of other people's money.  

Kaisa last month postponed its results announcement for 2014, saying that auditors needed more time to verify its accounts. There may be a “significant adjustment” to the figures, the company said on March 31 without saying when the results would be released.

The earnings and profitability of some Chinese property developers may deteriorate further in 2015 and more defaults can’t be ruled out, S&P said in a report Friday. It said developers’ annual results for 2014 indicate many are in “significantly worse” shape than the previous year.

If you are an investor in Chinese notes or Chinese stocks, consider this a warning.  I will remind you that these are slow-rolling crises that take quite a long time (in the timeframe of the average investor) to unwind.  Well, maybe not so slow as this morning Glorious Property Holdings, who just had their debt cut to Ca (junky junk) is struggling to come up with $19.5M of the $300M it must provide on 13% notes due Oct 25th.  Since the end of last year, the company also failed to meet repayment deadlines on $83M of principal and $66 in interest on unspecified borrowings this year  

“Glorious is currently the most likely to default among Chinese developers with dollar bonds outstanding,” said Rui Guo, a credit analyst at Mitsubishi UFJ Securities HK Ltd. “The series of overdue debt payments reflects the very weak cash flow and liquidity profile and heightened default risk of Glorious, which are worsened by the sharp losses incurred by the company.”

Their just-released 2014 Annual Report shows $500M in losses vs $500M in claimed profits in 2013, sales at Glorious have been declining in the past three years and gross profit turned negative for the first time last year since its initial public offering in 2009, Bloomberg-compiled data show.  “Compared to Kaisa, we don’t think Glorious’s current situation is much better off, since the company has been experiencing operation deterioration from 2012,” according to Kenny Wu, a credit analyst at Citigroup Inc.

I don't want to be overly dramatic about this stuff (and we are short on both China and Japan through FXI ($51.85) and EWJ ($13.26) as well as short the US markets as full disclosure) but I'm not going to let my people go through what people went through in 2008 if I can help it.  If you remember, it was a very slow roll to collapse while the markets made record highs in 2007/8 as well:

• Feb 27th, 2007 - Freddie Mac announces that it will no longer buy the most risky subprime mortgages and mortgage-related securities.  S&P 1,400
• Apr 2nd, 2007 - New Century Financial Corporation, a leading subprime mortgage lender, files for Chapter 11 bankruptcy protection.  S&P 1,424 
• June 1st, 2007 – S&P and Moodys downgrade over 100 subprime bonds.  S&P 1,536  
• June 7th, 2007 – Bear Stearns informs investors that it is suspending redemptions from its High-Grade Structured Credit Strategies Enhanced Leverage Fund. S&P 1,507
• July 24th, 2007 - Countrywide Financial Corporation warns of “difficult conditions.”  S&P 1,511 
• Aug 6th, 2007 - American Home Mortgage Investment Corporation files for Chapter 11.  S&P 1,476
• Sept 14th, 2007 - The Chancellor of the Exchequer authorizes the Bank of England to provide liquidity support for Northern Rock, the United Kingdom’s fifth-largest mortgage lender.  S&P 1,476
• Oct 15th, 2007 - Citigroup, Bank of America, and JPMorgan Chase announce plans for an $80 billion Master Liquidity Enhancement Conduit to purchase highly rated assets from existing special purpose vehicles.  S&P 1,548
• Dec 21st, 2007 - Citigroup, JPMorgan Chase, and Bank of America abandon plans for the Master Liquidity Enhancement Conduit, announcing that the fund “is not needed at this time.”  S&P 1,468
• Jan 11th, 2007 - Bank of America announces that it will purchase Countrywide Financial in an all-stock transaction worth approximately $4 billion. S&P 1,401 
• Jan 30th, 2007 - The FOMC votes to reduce its target for the federal funds rate 50 basis points to 3 percent (down 2.5% since prior Jan). The Federal Reserve Board votes to reduce the primary credit rate 50 basis points to 3.5 percent.  S&P 1,355 
• Feb 13th, 2008 - President Bush signs the Economic Stimulus Act of 2008 (Public Law 110-185) into law.  S&P 1,358
• March 7th, 2008 - The Federal Reserve Board announces $50 billion TAF auctions on March 10 and March 24 and extends the TAF for at least 6 months. The Board also initiates a series of term repurchase transactions, expected to cumulate to $100 billion, conducted as 28-day term repurchase agreements with primary dealers.  S&P 1,294
• March 14th, 2008 - The Federal Reserve Board approves the financing arrangement announced by JPMorgan Chase and Bear Stearns. The Federal Reserve Board also announces they are “monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly function of the financial system.”  S&P 1,288 
• March 18th, 2008 - The FOMC votes to reduce its target for the federal funds rate 75 basis points to 2.25 percent. The Federal Reserve Board votes to reduce the primary credit rate 75 basis points to 2.50 percent.  S&P 1,330 
• April 30th, 2008 - The FOMC votes to reduce its target for the federal funds rate 25 basis points to 2 percent. The Federal Reserve Board votes to reduce the primary credit rate 25 basis points to 2.25 percent.  S&P 1,385
• June 5th, 2008 – Standard and Poor’s downgrades monoline bond insurers AMBAC and MBIA from AAA to AA.  S&P 1,377 
• July 15th, 2008 - The Securities Exchange Commission (SEC) issues an emergency order temporarily prohibiting naked short selling in the securities of Fannie Mae, Freddie Mac, and primary dealers at commercial and investment banks.  S&P 1,214 
• July 30th, 2008 - President Bush signs into law the Housing and Economic Recovery Act of 2008 (Public Law 110-289), which, among other provisions, authorizes the Treasury to purchase GSE obligations and reforms the regulatory supervision of the GSEs under a new Federal Housing Finance Agency.  S&P 1,267 
• Sept 15th, 2008 - Bank of America announces its intent to purchase Merrill Lynch & Co. for $50 billion.  S&P 1,192 
• Sept 15th, 2008 - Lehman Brothers Holdings Incorporated files for Chapter 11 bankruptcy protection.
• Sept 29th, 2008 - The FOMC authorizes a $330 billion expansion of swap lines with Bank of Canada, Bank of England, Bank of Japan, Danmarks Nationalbank, ECB, Norges Bank, Reserve Bank of Australia, Sveriges Riksbank, and Swiss National Bank Swap lines outstanding now total $620 billion. The Federal Reserve Board expands the TAF, announcing an increase in the size of the 84-day maturity auction to $75 billion and two forward TAF auctions totaling $150 billion to provide short-term (one- to two-week) TAF credit over year-end.  S&P 1,100 
• Sept 29th, 2008 – The U.S. House of Representatives rejects legislation submitted by the Treasury Department requesting authority to purchase troubled assets (TARP) from financial institutions [see note for September 20].
• Oct 3rd, 2008 - Congress passes and President Bush signs into law the Emergency Economic Stabilization Act of 2008 (Public Law 110-343), which establishes the $700 billion Troubled Asset Relief Program (TARP). S&P 1,099  
• Nov 14th, 2008 – The U.S. Treasury Department purchases a total of $33.5 billion in preferred stock in 21 U.S. banks under the Capital Purchase Program.  S&P 873
• Nov 18th, 2008 - Executives of Ford, General Motors, and Chrysler testify before Congress, requesting access to the TARP for federal loans.  S&P 859  
• Feb 26th, 2009 - The FDIC announces that the number of "problem banks" increased from 171 institutions with $116 billion of assets at the end of the third quarter of 2008, to 252 insured institutions with $159 billion in assets at the end of fourth quarter of 2008. The FDIC also announces that there were 25 bank failures and five assistance transactions in 2008, which was the largest annual number since 1993. S&P 752

Now, reading all this in retrospect – it seems pretty obvious you should have cashed out in 2007 while the market was high but there were obvious signs of trouble, right?  But what actually happened?  Well, people have great gains and they decide to ride out a little 10% correction and, in fact, jump in "Buy the F'ing Dips" because it was working for the last 5 years (we rallied off 815 in 2002).

Then the market drops 10% more and now you are behind on your new purchases and just over even on your old ones but the Government is dumping money in and the Fed is dropping rates so things are going to be great so you stay in and then the market drops 10% more and 10% more and now you get religious because you BELIEVE it will all come back…

My theory (and we're mainly in CASH!!! at the moment) is that we're not going to miss much if we wait for the Nasdaq to hold 5,000 for a week or two while the other indexes catch up and confirm the next leg of the rally.  As I've mentioned, we still have our materials stocks and, if we're really in a huge Global Recovery – then they should do very well (and our Long-Term Portfolio just cracked +50% yesterday).

On the other hand, if I'm right and we shouldn't be ignoring these little warning signs in other parts of the World – then we can save ourselves a World of heartache AND be ready to buy the real dip when it comes (and we've found half a dozen bullish plays this week alone as earnings season gives us bargains).  Either way, I know I'm sleeping very well at night!  

Have a great weekend,

- Phil

Do you know someone who would benefit from this information? We can send your friend a strictly confidential, one-time email telling them about this information. Your privacy and your friend's privacy is your business... no spam! Click here and tell a friend!