The question has loomed over China Evergrande Group for months: Is the world’s most indebted developer “too big to fail”?
Investors finally have their answer. With a flurry of announcements that sent Evergrande bonds tumbling to record lows this week, the company and Beijing have made it clear that billionaire Xu Jiayin’s (許家印) property giant is headed for one of China’s largest-ever debt restructurings.
Barring a last-minute shock, holders of US$19.2 billion in Evergrande dollar notes face deep cuts as the company overhauls its mammoth balance sheet without a government bailout — a process that promises to be long, contentious and potentially risky for Asia’s largest economy.
Illustration: June Hsu
While ratings companies have yet to declare an official default, holders of two bonds issued by an Evergrande unit had not received overdue coupon payments by the end of a 30-day grace period on Monday.
S&P Global Ratings said on Tuesday that a default by the developer was “inevitable.”
Evergrande did not immediately respond to a request for comment.
The developments mark the beginning of the end for the sprawling real-estate empire started 25 years ago by Xu, setting off a lengthy battle over who gets paid from what remains.
Evergrande said in a brief exchange filing on Friday last week that it plans to “actively engage” with offshore creditors on a restructuring plan.
The company is planning to include all of its offshore public bonds and private debt obligations in the restructuring, people familiar with the matter said on Monday.
Evergrande, which disclosed more than US$300 billion of total liabilities as of June, becomes the biggest victim of Chinese President Xi Jinping’s (習近平) efforts to crack down on the free-wheeling real-estate sector and curb property speculation.
Beijing’s reluctance to bail out the developer sends a clear signal that the Chinese Communist Party (CCP) will not tolerate massive debt build-ups that threaten financial stability.
The question now is whether the government can limit the fallout.
The bonds of smaller, lower-rated real-estate firms have plunged in the past few weeks, driving yields above 20 percent, although they regained some ground this week as Beijing’s easing signals injected confidence into the market.
At least 10 firms have defaulted on onshore or offshore bonds since concerns about Evergrande’s financial health intensified in June.
Kaisa Group Holdings Ltd, a major issuer of dollar bonds, has been pushed to the brink in the past few days and was suspended in stock trading on Wednesday.
China Aoyuan Group Ltd said there is no guarantee that it will be able to pay its debt.
Home sales and prices have cratered, adding another headwind for an economy grappling with sluggish growth.
‘PLAYING WITH FIRE’
“They’re playing with fire,” said Cathie Wood, the head of Ark Investment Management, which pared its China holdings earlier this year.
For now, Chinese authorities are signaling that they plan to ring-fence Evergrande and limit contagion rather than orchestrate a rescue as they have done during past crises.
The People’s Bank of China on Friday last week reiterated that risks posed to the economy by Evergrande’s debt crisis can be contained, citing the developer’s “own poor management” and “reckless expansion” for the problems it faces.
The China Banking and Insurance Regulatory Commission said in a separate statement that loans for real-estate development and acquisitions should be issued in a “reasonable” manner.
The latest financial system support measures came on Monday, with China’s central bank releasing about 1.2 trillion yuan (US$188 billion) of liquidity via a cut in the reserve requirement ratio for most banks. The government pledged to support the housing market to better meet “reasonable” needs, adding to signs that it is to ease real-estate curbs.
Officials are also taking a more hands-on role at Evergrande. Xu was summoned by the Guangdong government last week after the company said it plans to work with creditors on a restructuring plan. Authorities in Evergrande’s home province are to send a working group to urge the builder to manage risks, as well as improve internal controls and ensure normal operations.
The company on Monday said that state representatives have taken the majority of seats on a new risk-management committee.
So far, containment efforts have not assuaged investors. While pain has so far largely been contained to China’s smaller offshore credit market, that is little consolation for developers that have relied heavily on international investors to raise funds. Borrowing costs have spiked for companies with the weakest balance sheets, including Kaisa and Fantasia Holdings Group Co.
In all, Chinese borrowers have defaulted on a record US$10.2 billion of offshore bonds this year, with real-estate firms making up 36 percent of that total, data compiled by Bloomberg showed.
“There is extreme stress in the market,” with about half of the developers in the country in deep financial distress and pricing in high default risk, said Jenny Zeng, co-head of Asia Pacific fixed-income at Alliance Bernstein.
Still, China’s bigger, higher-rated developers such as Longfor Group Holdings Ltd and Country Garden Holdings Co are holding up much better than their lower-rated rivals. Country Garden, the largest developer by sales, has seen its 2031 bond rebound to US$0.88 on the dollar, after dropping to US$0.73 last month. A 2024 note sold by China Vanke Co, the second-biggest firm, has rallied to trade above par.
“We expect sector divergence to continue,” said Iris Chen, a credit desk analyst at Nomura Securities Co. “The high-quality survivors of the game will gain, despite relatively high cash prices already, as they will have a better chance to restart normal refinancing, which will further strengthen their liquidity.”
China is also trying to limit the fallout on the broader housing market in a country where real estate accounts for about one-quarter of economic output and as much as 75 percent of household wealth.
The housing slump has intensified in the past few months after sales plunged and home prices fell for the first time in six years. Contract sales by the country’s top 100 developers plunged 38 percent last month from a year earlier to 751 billion yuan, sharper than the 32 percent drop in the previous month, preliminary data from China Real Estate Information Corp showed.
‘RIPPLE EFFECT’
Any slowdown in real estate could have a ripple effect not only on China’s economy, but on global growth. China’s growth slowed in the third quarter, with signs that there is more pain to come.
The US Federal Reserve last month warned that fragility in China’s commercial real-estate sector could spread to the US if it deteriorates dramatically.
China’s real-estate sector makes up almost half of the world’s distressed US dollar-denominated debt.
“Think about the cyclical risk out there if we lose China,” Wood said at a recent Milken Global Conference. “At the margin, China has been responsible for a tremendous amount of cyclical growth.”
China’s government is not standing pat. Xi oversaw a meeting of the CCP’s Politburo on Monday that concluded with a signal of an easing in curbs on real estate. The leadership panel, gathering in advance of a broader annual economic session that sets goals for the coming year, pledged to stabilize the economy next year.
For global bondholders, an Evergrande default is likely to start a prolonged battle for repayment. Chinese authorities have made it clear that the company should put homebuyers, suppliers, and retail investors — who bought the firm’s wealth management products — ahead of debtholders.
About 1.6 million homebuyers have put down deposits with Evergrande for properties that have yet to be completed.
“No matter what the outcome, offshore bondholders are last in line for payment and are certainly going to have to accept haircuts, possibly significant ones,” said Andrew Collier, managing director of Orient Capital Research Inc in Hong Kong.
With Evergrande’s dollar notes trading at about US$0.20 on the dollar, the market is already pricing in a cut of about 80 percent.
The key for bondholders is whether the company can speed up home sales and unload assets to raise cash so it can start settling its liabilities, said Gary Ng (吳卓殷), a senior economist at Natixis SA.
Evergrande’s offshore noteholders included Ashmore Group PLC and UBS AG, data compiled by Bloomberg showed.
Even as Evergrande’s stock and bond prices have plunged, Ashmore bought another US$100 million of bonds issued by the developer or its subsidiaries in the third quarter. The trades brought its holdings to more than US$500 million at the end of September, the data show.
Further market reaction to Evergrande’s missed payments might be driven by how the restructuring process plays out, said Jim Veneau, head of Asian fixed income at AXA SA.
“An orderly restructuring, where the company can run its operations as normally as possible and refrain from distressed asset sales, will substantially help contain further damage across the sector,” Veneau said.
The single biggest loser in dollar terms might be Xu, who once owned more than 70 percent of the company before recent stock sales.
The plunge in Evergrande’s share price this year has cut the chairman’s wealth by 73 percent, or about US$17 billion, the Bloomberg Billionaires Index showed.
Once the second-richest man in China, Xu now ranks 75th.
For years, the son of an impoverished wood cutter who built one of China’s biggest real-estate firms and later branched out into electric vehicles, tourism and soccer clubs, has been able to count on the support of Beijing or other tycoons to bail him out.
This time, he appears to be on his own.
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