- Chinese authorities will not directly bail out the embattled property developer, but they will be keen to prevent a complete collapse
- Beijing is likely to to use a cocktail of proven tricks: rolling over debt, haircuts on assets and emergency payments to the vulnerable
Evergrande has encountered unprecedented difficulties, but it has denied it is heading towards bankruptcy
Chaotic scenes of hundreds of angry creditors outside the offices of China Evergrande demanding their money back have made for surreal viewing.
After all, the property developer looks quite solid on paper, with billions of dollars worth of assets that outweigh liabilities, and years of reported profits.
Until recently, chairman Xu Jiayin, or Hui Ka Yan in Cantonese, looked the picture of a well-connected Chinese businessman – rubbing shoulders with tycoons in Hong Kong and being hosted at the Communist Party’s 100th anniversary celebrations in July.
But every dollar of debt owed by China Evergrande – which includes about 2 trillion yuan (US$309.2 billion) on the books and an estimated 1 billion yuan of off-balance debt – is worryingly real.
The company has denied it is heading towards bankruptcy and is pushing forward with ongoing projects. Ideally, it can complete its new buildings and walk away from its current difficulties. But that scenario is far from certain – and stock and bond investors are acting accordingly.
The value of its assets will also be tested on the market. It would be unrealistic for China Evergrande to expect to be able to sell its land and property at paper value under current circumstances, something it seems to recognise itself.
For Chinese authorities, the debacle has become another “grey rhino” to deal with. For years, Beijing has warned that debt-fuelled property development is not sustainable and tried to contain the risks.
But property has been a key driver of China’s economic growth. Local governments rely on revenue from land sales, families invest in housing, and developers – who cannot borrow easily from banks – have tapped other sources of funding, which in the end often comes from the banking system.
Despite the talk, China Evergrande will not become a Lehman Brothers moment. Chinese authorities have huge influence over creditors. Beijing will not bail the company out directly, but it will be keen to avoid a complete collapse as the shock waves could envelop banks, suppliers, retail investors and even local authorities.
The final solution will be another cocktail of proven tricks: rolling over debt, haircuts on assets and emergency payments to the most vulnerable. Those responsible for the situation will be held accountable.
At the end of the day, the losses will spread across stakeholders and span a long time. So expect the fate of China Evergrande to be a slow burnout rather than quick meltdown.
Evergrande’s staunchest allies drop out as Chinese property developer’s creditworthiness deteriorates amid debt woes
Joseph Lau Luen-hung and Chan Hoi-wan sold 138 million Evergrande shares several times last month for HK$500 million, according to exchange filings.
Lau and Chan cut their stakes to 7.96 per cent, second only to Hui Ka-yan’s controlling stake of 70.7 per cent in Shenzhen-based Evergrande.
Two of the property magnate Hui Ka-yan’s staunchest allies appear to be bailing out of China Evergrande Group, selling a large chunk of the developer’s stock ahead of a gathering storm and deteriorating credit ratings over US$300 billion in liabilities.
Joseph Lau Luen-hung, the founder of Hong Kong developer Chinese Estates Holdings Limited, and his wife Chan Hoi-wan, sold 138 million Evergrande shares several times in the past month for about HK$500 million (US$64 million) in total, according to exchange filings. Lau and Chan reduced their holdings in the Shenzhen-based developer to 7.96 per cent, second only to Hui’s controlling stake of 70.7 per cent.
The couple’s disposals followed an 85 per cent plunge in Evergrande’s stock price and market value in the past year, as the property developer struggles to find cash to settle financial liabilities estimated at US$300 billion.
Every avenue of bank financing for Evergrande has been choked off by the People’s Bank of China after the company, the world’s most indebted developer, blew through all three of the central bank’s “red line” debt allowances last year. Spokespeople of Chinese Estates and Evergrande declined to comment.
In a friendship and alliance forged through weekly card games going back more than a decade, Chinese Estates had been involved either as a buyer or the seller in almost every financial transaction by Evergrande since Hui listed his property company for HK$6.5 billion in Hong Kong.
Lau was the cornerstone investor and subscriber of US$50 million of Evergrande’s shares during its 2009 initial public offering.
After Lau was convicted in 2014 in absentia by a Macau court of a bribes-for-land scheme, Evergrande swooped in to buy Chinese Estates’ 26-storey Mass Mutual Tower in Wan Chai for HK$12.5 billion, a price tag that was much higher than prevailing market valuations. Chinese Estates’ head office remains on the highest floor of the tower, renamed Evergrande Centre in 2015.
In the same year, Chinese Estates sold some offices in Chengdu for HK$6.5 billion, and a residential property complex in Chongqing for HK$1.75 billion, all to Evergrande.
Lau and Chan are not the only allies to be heading for the exits, as Evergrande admitted in a statement that it had “encountered unprecedented difficulties.”
Xia Haijun, vice-chairman and chief executive of Evergrande since 2014, sold HK$115.6 million of shares in the developer’s electric car unit and property management arm in August. The pay package of Xia, 57, was HK$275 million in 2018, making him the second highest-paid executive among Hong Kong’s publicly traded companies. Only Tencent Holdings’ Martin Lau Chi-ping, president of Asia’s largest public company, earned more, according to exchange filings.
Evergrande faces a key liquidity test next week when it is due to pay US$83.5 million in interest on September 23 for a dollar-denominated note, in addition to 232 million yuan (US$36 million) for a renminbi note, according to data compiled by Bloomberg.
Nine bonds issued by Evergrande’s flagship company with 53.5 billion yuan in face value were placed on restricted trading on the Shanghai and Shenzhen exchanges this week, after a local credit agency slashed their rating.
S&P piled in, downgrading Evergrande’s creditworthiness to the junk status of “CC”, implying that the company’s bonds are of “very high risk”, non-investment grade.
“The liquidity and funding access of Evergrande are shrinking severely, as shown by an announced material drop in sales, a fall in the cash balance, and the continued use of physical properties to settle payments,” S&P said. “The company may not be able to service debt in time, which will lead to a default scenario including the possibility of debt restructuring.” Adding to the woes, HSBC, ICBC (Asia) and a host of other banks in Hong Kong have stopped approving mortgage loans for buyers of Evergrande’s Emerald Bay apartments in Tuen Mun, amid concern about the developer’s ability to complete its inaugural project in the city.
Last week, hundreds of investors and Evergrande staff staged a protest at the company’s Shenzhen head office to demand refunds of investment products that they bought from the company. The unusual event comes at a sensitive time for China’s authorities, as they are anxious to avoid civil disturbances during the centenary of the ruling Communist Party.
Hui, also known as Xu Jiayin in mainland China, is a delegate to the Chinese People’s Political Consultative Conference (CPPCC), the advisory body to the legislature.
To placate angry staff and investors, Evergrande plans to offer discounted real estate products in lieu of cash, according to creditors who have been informed about an announcement scheduled for September 20.
What price can China Evergrande expect for its Hong Kong headquarters
Evergrande bought the 26-storey office tower in Wan Chai from Chinese Estates Holdings for HK$12.5 billion (US$1.61 billion) in 2015
Cash-strapped developer is said to be in talks to sell the asset to Guangdong-based Yuexiu Property for US$2 billion, media reports say.
China Evergrande Group is rushing to sell assets to repair its balance sheet. Under state pressure to strengthen its balance sheet, the developer has held talks to sell its interest in Hong Kong-listed car-making unit and property management arm.
The Shenzhen-based firm is seeking to sell the 26-storey China Evergrande Centre in Wan Chai that serves as its headquarters in Hong Kong to mainland peer Yuexiu Property, Bloomberg and other mainland media reported last week.
The trophy building, bought from Chinese Estates Holdings in 2015, is China Evergrande’s single largest asset. Selling the harbourside property in Wan Chai will help boost its liquidity, which is vital to meeting one of the Chinese central bank’s “three red lines” deleveraging campaign.
Here’s why billionaire founder and chairman Hui Ka-yan is trying to save his property empire.
What is behind Evergrande’s financial stress?
Hui’s flagship is regarded as the world’s most-indebted developer some yardsticks. The group had 1.95 trillion yuan (US$301 billion) of total liabilities at the end of 2020, according to its latest financial accounts. They included 716.5 billion yuan of interest-bearing borrowings, which has since been trimmed to 570 billion yuan in June, according to a press statement.
The billionaire has made efforts to reduce debt and restore stakeholder confidence after it came under fire by Beijing for its bloated borrowings, which has prevented the group from accessing new loans from the second half last year.
But these measures have not helped its share price, which has plunged by some 75 per cent in Hong Kong over the past 12 months.
What do we know about China Evergrande Centre?
The grade A building, located on Gloucester Road, was built in 1985. The 26-storey tower has a total floor area of 345,424 sq ft.
Evergrande paid HK$12.5 billion (US$1.61 billion) to buy the building, then known as Mass Mutual Tower, from Chinese Estates Holdings, a Hong Kong developer controlled by one of his billionaire friends Joseph Lau Luen-hung. Evergrande had agreed to pay in eight instalments over six years.
At the time of the deal, the building had a 100 per cent occupancy rate, but today this has dropped to mid-70 per cent, according to property consultants Colliers.
What was so significant about the deal?
The US$1.61 billion deal set a record for the single largest transaction for an office building in Hong Kong. The price of HK$36,187 per square foot was also an all-time high. However, China Evergrande shares tumbled 4 per cent following the announcement, as the market considered the price as excessive.
What is the current valuation of the building?
It has been reported that Evergrande is in talks with Guangdong-based Yuexiu developer, to sell it for US$2 billion. Property consultants said the reported price tag was well above its market value.
Property consultants said taking into account the market sentiment and the current market prices, the value of the building is estimated at between US$1 billion and US$1.35 billion.
“A valuation of HK$10.5 billion or HK$30,000 per square foot is far more reasonable,” said Vincent Cheung, managing director at Vincorn Consulting and Appraisal.
While HK$30,000 per square foot may seem high for Wan Chai compared to neighbouring Admiralty or Central, Evergrande Centre’s harbour views, advertising and naming rights allow it to command a premium compared to other office towers, he added.
What is the outlook for Hong Kong’s office market?
Cheung said office rentals for grade A buildings in Wan Chai are on average HK$45-HK$55 per square foot, which is lower than the HK$50-HK$70 per square foot in the pre-pandemic era.
“We are seeing a softened market and no increase at all in rent, this makes a sale for Evergrande at HK$10.5 billion reasonable.”
Chinese regulators summon Evergrande executives, urge them to keep operations stable, diffuse debt risks
China Evergrande officials were summoned for a meeting by the People’s Bank of China and China Banking and Insurance Regulatory Commission.
Regulators urge Evergrande to follow rules and disclose information in a timely manner to prevent rumours from spreading.
China Evergrande Group has become the latest Chinese company to be given a talking-to by the country’s top financial regulators.
The People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) said on Thursday that they had summoned China Evergrande executives for a meeting, urging the world’s most indebted developer to keep operations stable and actively diffuse debt risks.
“As a leading real estate company, Evergrande must earnestly implement the stable and healthy development strategy of the property market set out by the central government … and maintain the stability of the property and financial markets,” PBOC and CBIRC said in a joint statement.
Evergrande did not immediately respond to a request for comment.
China’s top financial regulators have in recent months summoned some of the country’s biggest companies, asking them “to do the right thing”, as they seek to fend off systemic risks and ensure that private enterprises do not upset the balance of the existing, centrally planned economy.
In April, top tech firms that run online financial businesses, including Tencent Holdings, Tik Tok-owner ByteDance and Didi Finance were summoned by the PBOC and three other financial regulators to “step up anti-monopoly measures” and highlighted that “financial businesses should serve the real economy as well as reduce financial risks.”
The PBOC and CBIRC also told Evergrande to follow rules and disclose information of major events in a timely manner to prevent rumours from spreading in the market.
The regulators’ concerns come close on the heels of the executive reshuffling at Hengda Real Estate Group, Evergrande’s closely-held mainland China property unit.
Earlier this week, billionaire Hui Ka-yan, who controls the Hong Kong-listed China Evergrande, stepped down as chairman of Hengda and promoted Hengda director Zhao Changlong to the position, according to information provided by the National Enterprise Credit Information Publicity System, a state-owned credit data portal.
The listed company did not make any public announcement regarding the personnel change, resulting in rumours of Hui’s exit from the group spreading online and causing its shares to fall.
However, an Evergrande spokesperson responding to media inquiries said that it was “a normal personnel change” and it did not have any impact on the management structure or a change in shareholdings.
The developer is facing a hostile market as the company attempts to steady the ship amid concerns about its finances. Unable to borrow, the group has been selling assets to avert a liquidity crunch.
Despite slashing its interest-bearing liabilities by one-third to 570 billion yuan (US$87.9 billion) in June from last year’s peak, global credit-rating firms have downgraded its creditworthiness amid concerns about its debt repayment capacity.
China debt: Evergrande’s fate shows ‘too big to fail’ may no longer apply as crackdown gathers steam
Evergrande is perhaps the most prominent in a growing list of high-profile Chinese companies at risk from extravagant borrowing in recent years.
Analysts say the developer’s financial and political troubles could signal ‘more tolerance for defaults’ as Beijing pushes ahead with deleveraging.
On July 1, under cloudy skies in China’s capital, Hui Ka Yan, the 63-year-old billionaire chairman of the nation’s second-largest property developer, walked through Tiananmen Square as part of Beijing’s celebration of the Communist Party’s centenary.
The head of China Evergrande flashed his trademark smile as he posed for photos at one of the nation’s most culturally significant sites, surrounded by some 70,000 onlookers who had gathered at the huge square.
His appearance among China’s ruling elite was seen as a sign of political favour for the country’s most-indebted developer, but it did nothing to prevent his company from falling deeper into a crisis two weeks later after a court froze some of its bank deposits.
The court order caused a sharp slump in the firm’s share and bond prices that hurt overall market sentiment, but it also stoked concern that the company’s toxic debt level would lead to defaults in hundreds of its partner firms and financial institutions, putting the income and jobs of millions of people in danger.
Evergrande is perhaps the most prominent of an expanding list of high-profile companies under threat from extravagant borrowing in recent years. Its financial and political troubles come amid growing concern about systemic financial risks in China, due in part to a sharp rise in corporate debt levels.
Beijing has made reducing debt, or deleveraging, one of its top policy priorities, as extensive credit expansion is seen as a ticking bomb at the heart of the world’s second largest economy.
To keep a lid on rising property prices, Beijing has put pressure on developers like Evergrande.
“Amid credit tightening, financial deleveraging and a decline in liquidity, debt risks in property companies, local government financing vehicles and zombie enterprises have begun to surface, some of them have already been caught in liquidity crises and are on the verge of not surviving,” Ren Zeping, the former head of Evergrande’s research institute, wrote in a note on July 26.
“It is necessary to estimate and prepare for the downward economic pressure” resulting from the government’s deleveraging campaign, said Ren, who now serves as the chief economist at Soochow Securities.
Consequences of the debt-reduction programme are already starting to be felt, with the tighter credit environment leading to more – and larger – corporate bond defaults. This trend is expected to continue, testing how well the country is able to reduce moral hazard without causing significant economic pain.
Indebted companies with only limited profits may be unable or unwilling to invest more in production facilities if they are required to pay old loans to meet regulatory requirements, which could hit the country’s economic momentum in the second half of the year, analysts warned.
China’s ratio of outstanding debt to gross domestic product (GDP), or the so-called macro leverage ratio, declined to 265.4 per cent at the end of June from 267.8 per cent three months earlier, down for the third straight quarter, according to data from the National Institution for Finance and Development (NIFD) under the Chinese Academy of Social Sciences (CASS).
The debt-to-GDP ratio shot up to a record of 285 per cent in the third quarter of 2020 as China pumped money into the economy in response to the pandemic.
The leverage ratio of non-financial corporations had improved for the fourth consecutive quarter as of the end of June, declining to 158.8 per cent, after pandemic-related stimulus sent the figure to a record high of 165.2 per cent a year earlier, the CASS figures showed.
China had temporarily achieved a “beautiful deleveraging”: a scenario in which the debt-to-income ratio goes down without resulting in broad deflation while achieving positive economic growth.
However, behind the seemingly healthier financial picture, the principal amount of onshore corporate bonds defaulted on rose to 62.4 billion yuan (US$9.9 billion) in the first six months of the year, up 18.9 per cent from a year earlier, according to Fitch Ratings.
China is shifting its growth model to focus on efficiency … this means more tolerance for defaults of unfit firms, including SOEs
The value of maturing bonds in China was likely to rise to between 5 trillion yuan and 5.4 trillion yuan in the second half of the year, from 4.9 trillion yuan in the first half, Fitch said.
S&P Global Ratings also sounded the alarm about a possible increase in bond defaults in the second half of the year, given the large size of maturing debt, tighter government policies and the erosion of financial flexibility among local governments due to the impact of the pandemic on their revenue bases.
S&P warned there were more Evergrande-sized conglomerates at risk of default in the future, with average outstanding onshore bonds some 1.6 times the size of last year and nine times that of 2015.
“China is shifting its growth model to focus on efficiency … this means more tolerance for defaults of unfit firms, including SOEs,” the agency said in a note on June 21, referring to state-owned enterprises.
“China’s corporate bond default rate has been rising but remains abnormally low versus global markets.”
Since late 2020, several high-profile bond defaults among SOEs have shaken investor confidence that local governments will always bail out local firms to avoid systemic risks.
This April, China Huarong Asset Management, the nation’s largest bad-debt manager, failed to publish its 2020 results, another wake-up call for investors that even central government-owned institutions might no longer enjoy blanket guarantees from Beijing.
“Increasingly more mainland companies have got into financial problems, which has made the market reconsider whether those that are ‘too big to fail’ may also fail,” analysts at Everbright Sun Hung Kai said in a note on July 27.
Beijing policymakers announced stricter regulation of corporate bond issuance in April, requiring issuers to disclose additional information on debt-servicing capability. Before that, the central government imposed new restrictions on the ability of major property developers like Evergrande to borrow capital.
Property developers suffered the most defaults in the first half of the year, with the sector’s net new financing at a negative 47 billion yuan, meaning it became harder to borrow as companies were forced to repay large amounts of debt, according to data from Zhongtai Securities.
China’s pledge to reach carbon neutrality by 2060 is also likely to put liquidity pressure on metals and mining companies in coming months, with investors less willing to lend given the uncertain outlook for the sector.
Top Chinese decision-makers have shown they are paying attention to the potential negative impacts of deleveraging, repeatedly stressing the need for “cross-cyclical regulation” during recent conferences and surprisingly cutting banks’ reserve requirement ratio last month.
“The key variant for [China’s] monetary policy in the second half of the year is not inflation but debt,” Peng Wensheng, chief economist at prominent investment bank China International Capital Corporation advised in an article at the end of June.
The NFID report warned that if companies rush to repay their debts as soon as they make a profit, and there is no new investment, “it is likely to cause a balance sheet recession.”
While there is concern that private-sector firms have become the major victims of leverage containment, the debt ratio of SOEs has continued to rise, according to Zhang Xiaojing, director of the NFID.
“It can be seen that there is also a serious problem of fairness in deleveraging,” he said at the Qujiang Forum in Xi’an in late May.
Downward economic pressure is expected to mount for China in the second half of the year, as weaker exports and the recent Delta variant outbreaks weigh on activity - a preview of which was seen in the decline of the purchasing managers’ indexes in July.
In the meantime, the impact of the Evergrande drama continues to ripple through financial markets.
Last Friday, S&P downgraded Evergrande and its subsidiaries by two levels to CCC, one of the lowest levels of junk and just two notches above the designation for borrowers that have defaulted, citing an escalating risk of non-payment on debt. The move was the agency’s second cut in under two weeks, and Moody’s and Fitch have taken similar action.
“Unless the government tightens demand severely, the solvency risk [for Evergrande] will remain low,” Raymond Yeung and Xing Zhaopeng, economists at ANZ Banks, said in a note last month.
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