Just the beginning for real estate sector restructuring

What is your view of the bond picture of Vietnam?

Xavier Jean, senior director of Corporate Ratings at S&P Global Ratings

We believe some of the restructuring and defaults in the sector is just the beginning or a wider trend of debt extensions, restructurings and defaults in Vietnam’s real estate sector, with possible contagion to related sectors and smaller leveraged companies. When facing distress, we have observed several strategies. Moratoriums or debt extensions have been the more frequently used strategy to deal with over-leverage and liquidity pressures. But this strategy only works in the long term if the underlying business is sound and the entity has a clear path to future cash flow growth.

If not, extending the debt provides only temporary relief, and leads to another round of default when the rescheduled debt is due.

When a company’s leverage is too high compared with its cash flow generating potential, an option we have observed is agreeing with creditors on a debt haircut or a debt-to-equity (or debt-to-asset) swap to reduce the absolute quantum of debt and revert to a more sustainable capital structure. Given the underlying volatility of the real estate sector in Vietnam, we would regard a ratio of debt/earnings before interest, taxes, depreciation, and amortisation below 3x as a more sustainable capital structure – that ratio exceeds 5x for many Vietnamese developers today.

Companies can also sell inventory (constructed homes or a stake in projects) to free up cash. But they would have to do so at lower prices given the market environment, which they may not want to.

Another option is to kick the can down the road and lengthen payments to suppliers and contractors. Many have done this already and may not be able to squeeze much more cash in. Offering more collateral on bank loans could be an option, but with falling collateral prices that may will not solve the problem.

The last option is equity injections from sponsors, but that’s going to be dependent on the sponsor’s ability to raise funding. In this sector, very few dividends have been paid as companies have focused on growth.

What is your expectation for the bond volume ahead?

New domestic issuances are likely to reduce in 2023 as domestic bond investors shy away given challenges in the real estate sector. Leverage in the sector has spiked over the past five years as demand was robust, with debt at the largest listed developers multiplied by 3-5 times, sometimes more. Refinancing in the domestic market (bank credit or domestic bonds) was a no-brainer when operating conditions were strong between 2018 and the first half of 2022. But now, funding access has become more expensive and selective.

Vietnamese companies facing near-term liquidity strains will face significant challenges in accessing the domestic bond market, especially if they have not raised domestic bonds before. With Decree No.65/2022/ND-CP, it will take much longer to put together a bond offering: companies need a fresh set of financials, and sufficient disclosure (a weakness in Vietnam’s corporate sector); in the US bond market, companies also need to consider the currency mismatch of borrowing in USD while their revenues are generated in VND, as hedging costs can be significant.

The real estate sector has faced significant negative headlines over the past few weeks, and the appetite of banks and the bond market for this higher-risk segment is likely to be limited for at least the next six months. Chinese developers facing similar trends (weakening domestic sales, high leverage, liquidity stress) have been largely shut out of the domestic and USD bond market for almost one year now, while domestic banks have been much more selective. We also believe creditors will be keen to wait how some of the distressed situations pan out before increasing their exposure to the sector: how companies restructure, how long it takes, and the recovery prospects.

This high-leverage situation and recurring negative headlines is also likely to create a vicious circle: real estate buyers could stay on the sidelines for now as they want to make sure that flats that have paid for are delivered – a situation similar to China, though on a much lower scale.

But presales are a key source of cash flows for Vietnam developers and without this source, it will be even more difficult for them to make good on their maturities. We are already observing a high double-digit drop in new sales in Q4 of 2022 for developers that have already published Q4 results. We are also watching for the contagion effect, and the first sector is construction and related services. But with the drive towards more transparency and the focus on governance, we believe any highly leveraged company with below-average transparency may face more challenges in accessing timely funding.

How should the government deal with this situation?

We do not provide advice or recommendations, but based on our analysis of the situation and recent government measures, we believe that in the near term, there is little that the government can do to solve the situation. The most obvious option, which we are seeing in China for example, would be incentivising banks (especially state-owned) to roll over the loans, but Vietnamese banks often do not have the capital resources and profitability to do that on a large scale. We have observed the issuance of guaranteed bonds or real estate funds, but this would have fiscal costs to the government.

Governance and transparency took a back seat during boom times in this largely unlisted and nascent market. It is now coming back to the forefront as investors are asking more questions. Some of the measures taken by the government, such as Decree 65 regarding transparency and disclosure, will help shore up confidence in the long-term. But they will be painful in the short term as it reduces the investor pool.

There was interesting data from the Vietnam Bond Market Association showing that besides government and government-linked entities, real estate or banking/finance companies accounted for nearly two-thirds of corporate issuances in 2020 and 2021, and about 80 per cent for issuances between January and October 2022. I am not too worried about the more solid government-linked companies, but smaller private entities are very dependent on this funding. Another interesting data point was that about 60 per cent of developers are unlisted, so the information flow is limited and that may make it more difficult to obtain timely refinancing.

Bond pressure retained in real estate If a draft decree amendment on bonds is soon passed, real estate businesses will likely be given a helping hand in the form of time to restructure their cash flows.