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China’s most indebted property empire – Evergrande – is again in focus this week amid rising worries about its financial health. Long described as a poster child for highly leveraged companies in China, Evergrande is now facing financial problems, credit downgrades, and pointing towards a potential default. Globally, it was the biggest property company, only three years ago. Now, is quickly becoming the biggest threat to China’s $50 tn financial system.
Growing concerns over Evergrande’s access to financing have wiped out billions of dollars from the company’s market value. Investors are anxiously watching bad news piling upon Evergrande, with its stock collapsing over 70% in 12 months period and its dollar bonds plunging to record lows.
Evergrande announced that it has decided to forego the special dividend payout, the first to be announced since 2018. The company’s reply on dividend cancellation citing ‘current market environment’ and creditors’ has now further spooked investors about its financial capabilities.
Evergrande’s founder – Hui Ka Yan – has now lost more than $20 bn in fortune on paper. As per the Bloomberg Billionaires Index, Hui’s wealth is down more than half from the 2020 peak. While the regulators are using a wide range of policy levers on the company, the billionaire has been telling bankers to ignore the recent headlines about his troubled property group.
Evergrande’s relations deteriorate amid debt woes
As Evergrande faces mounting debt pressure, the company’s banking relationships have also dramatically deteriorated in recent weeks. On fears of investigations by Chinese regulators, several banks and bond investors have shied away from providing it long-term funds.
In recent news, Mainland financial regulators have launched a probe into financial dealings between Evergrande and its largest shareholder, Shengjing Bank. Apart from this, the company’s founder Hui was called in to meet regulators last month, where he was reportedly urged to solve the liquidity pressure as quickly as possible.
Earlier, Reuters reported that regulators want the company to disclose details of commercial paper issuance in their monthly reports to curb ballooning debt.
In mid-July, the Chinese court froze $20 m (132 m yuan) worth of bank deposits at the behest of one of its creditors, China Guangfa Bank, that sued Evergrande to recover its debt. Following this, sales were halted on Evergrande projects in a city in Hunan Province.
The deposit freeze led to a domino effect causing several major banks from Hong Kong – HSBC, Bank of China’s Hong Kong unit, Hang Seng Bank, Bank of East Asia, Industrial and Commercial Bank of China (Asia) and Standard Chartered – to bar from providing mortgages to buyers of Evergrande’s unfinished residential projects in the region.
Nomura credit analyst Iris Chen told Bloomberg, “Evergrande could find it difficult to get out of this vicious debt default cycle as confidence in the company has collapsed across almost all stakeholders.” Amid escalating troubles, the developer then agreed to clear the debt with China Guangfa Bank.
Driven by the recent weakening in Evergrande’s funding access, Standard & Poor’s (S&P) Global Ratings recently cut its credit rating by two notches. In June and early July, Moody’s and Fitch also downgraded the developer’s rating.
Chinese trust firms – the second-biggest lenders to Evergrande after banks – have also been reassessing their exposure to the group. The developer has breached all three red lines as per Chinese borrowing limits and is not allowed to raise any interest-bearing debt above June 2019 levels. It is also prohibited from taking on additional debt by three Chinese banks, that have a combined $7.1 bn (46 bn yuan) of credit exposure to Evergrande as of June 2020.
Evergrande’s dramatic debt-cutting
The Shenzhen-based developer has been under pressure since early 2020 to clear the rising debt. As per its latest report, Evergrande has only $24 bn (158.8 bn yuan) in cash and cash equivalents at the end of 2020, against $51 bn (335.5 bn yuan) of interest-bearing debt coming due in 2021. The company’s main onshore subsidiary had about $32 bn of commercial bills outstanding as of December last year, which shows its growing reliance on such financing.
To shrink its growing debt load, the company has ramped up home sales at significant discounts, offloaded commercial properties, and considered asset sales in non-core businesses.
Evergrande has $301 billion in total liabilities as of the end of 2020. According to S&P ratings, the company faces over $6 billion in offshore maturities in 2022.
As per Fitch Ratings, Evergrande has not issued any offshore bonds since early 2020 and its bonds due in 2025 are trading at around a 27% yield. The developer is Asia’s biggest issuer of high-yield dollar bonds, according to UBS analysts.
In a move that would also make its books look healthier, Evergrande earlier in March unveiled plans to roughly halve its debt over the next two years and hit $53 bn (350 bn yuan) or less by June 2023.
It also pledged to meet at least one of China’s regulatory borrowing limits of the ‘three red lines’. The developer has also cut its total borrowings to about $88 bn in late June, down 20% since the end of last year.
Beijing’s dwindling confidence in real estate
China’s property developers are among the biggest junk bond issuers in Asia. Rising defaults from the real estate sector have spooked China’s bond markets. In a move to create a more disciplined and efficient market, Beijing has been discouraging debt-fuelled expansion by taking a tougher stance with indebted giants such as China Fortune Land Development Co, China Huarong Asset Management Co., and China Evergrande Group.
The treatment of recent distressed cases in China has triggered speculation about a potential debt restructuring. According to Goldman Sachs Group’s recent report, Chinese policymakers are much less willing to extend support to large corporations. In its latest report, GS said that ‘the notion of too big to fail may no longer apply to China’s borrowers.’
To make the financial system more resilient over the long run, the country has already rolled out a string of property curbs starting last year, that focuses on strengthening regulations on-property activities, property gifting, and checking on rapid housing price surges.
Furthermore, the central bank introduced the policy called the “three red lines” last year, which allows a maximum of 70% liabilities to assets, cap net debt at 100% of equity, and require developers to hold cash in excess of short-term borrowings. Recently, China’s Vice Premier Han Zheng also announced steering away from using real estate to provide short-term boosts for the economy.
