China Evergrande: investors assess the risks of probable default
HONG KONG – Intensifying crisis within China Evergrande group, the world’s most indebted real estate developer, is shaking China’s junk bond market and fueling fears of consequences damaging to the rest of the country’s financial system.
International investors are no longer content to avoid bombarded Evergrande bonds. Debt issued by other strained developers has also collapsed. Banks exposed to the Chinese real estate sector are under scrutiny.
And with angry creditors invading Evergrande’s headquarters and unpaid contractors slaughtering tools at its construction sites across the country, the debacle is also drawing public attention.
The question for investors – and for Chinese authorities – is whether the problem will start to grow on its own or whether contagion can be avoided.
The ICE BofA Asian Dollar High Yield Corporate China Issuers Index slipped to a more than 16-month low last week and the premium that junk bonds issued by the United States impose on Chinese borrowers compared to their counterparts in the continent hit an all-time high this month, indicating global investor aversion to Chinese debt.
“Given the relevance of real estate in China, better business health after the pandemic will not be enough to stop the surge in credit risk,” said Alicia Garcia Herrero, chief economist for Asia-Pacific at Natixis. “Evergrande’s contagion to other developers will become more visible among private and high yield debtors. Banks with higher real estate exposure can also be distinguished with wider bond spreads.”
The real estate sector has been the backbone of the growth of the world’s second-largest economy for years. Real estate investment has averaged 13.5% of gross domestic product over the past five years, according to Fitch estimates, three times the level of the US economy. By adding construction and related industries, the number doubles, according to a study released by the Massachusetts National Bureau of Economic Research in August of last year.
Chinese President Xi Jinping is trying to temper the nation’s obsession with property and has said “housing is for living, not for speculating.” In recent months, authorities have targeted everything from mortgage approvals and bank exposure to housing, to growth in rents and land prices, to better control the market. They also imposed strict guidelines on the leverage of real estate companies as part of the “three red lines” policy, with those that do not meet the limits to borrow more.
Non-performing loans to the real estate sector jumped 30% at the five largest banks to reach 97 billion yuan ($ 15 billion) in the first six months of the year, according to the documents.
Real estate companies accounted for around 30% of bond defaults in the first half of the year, banks and prime brokers no longer accept debts issued by certain highly indebted developers as collateral.
Chinese regulators have already warned of the wider risks to the country’s financial system if Evergrande’s $ 305 billion in liabilities are not contained, and told it to urgently reduce its debt. The company owes more than 128 banks and about 121 non-bank institutions, according to the contents of a leaked letter Evergrande wrote to the government late last year.
Things are coming to a head. Last week, disgruntled retail investors who bought the company’s wealth management products descended on Evergrande’s headquarters in Shenzhen to demand their money, after being offered only installment repayments. Evergrande offshore bonds are now trading below 30 cents on the dollar, indicating an expected default. Bloomberg reported that the Department of Housing and Urban and Rural Development told banks Evergrande would not be able to pay its debts due on September 20. The company must also pay 15 bond coupons before the end of the year, starting September 23. .
The company retained Houlihan Lokey and Admiralty Harbor Capital as financial advisers to assess its capital structure and explore solutions to the liquidity crisis, warning that non-renewal of payments “could lead to cross-default under the agreements. of the group’s existing financing “.
Across the industry, higher borrowing costs over an extended period could weigh on Chinese leveraged companies and ultimately lead to an increase in defaults in banking and wealth management.
Bonds issued by another heavily indebted real estate developer, Guangzhou R&F, are listed at 58% of face value, up from 72% earlier this month. Moody’s downgraded the group’s credit rating this month and warned it could have difficulty refinancing its debt. Bonds from Shenzhen-based Fantasia Group, another developer facing refinancing issues, were trading at 56 cents to the dollar.
Volatility in domestic and US dollar bond markets will exacerbate refinancing difficulties for some developers, S&P Global ratings said in a note. He estimates that the developers he assesses face 480 billion yuan in domestic and offshore bond maturities within a year, or 22% of their unrestricted liquidity level, as of June 2021.
“When refinancing becomes impossible, developers will have to repay maturities in cash, taking resources for the land and even construction,” he said.
Credit spreads on the onshore debt of Chinese issuers have not yet widened like those of offshore junk bonds. Analysts and investors Nikkei Asia spoke to still believe the government will step in before Evergrande or its smaller peers cause a systemic shock. They also point out that banks have sufficient reserve to avoid a real credit crisis.
A People’s Bank of China sensitivity test released earlier this month showed that while the bad debt ratio for home loans increased by 15 percentage points, and for mortgages by 10 percentage points, the average ratio capital adequacy of the 4,015 banks assessed would only rise from 14.4% to 12.3% – still above the regulatory minimum of 10.5% to 11.5%.
As a result, bonds issued by larger developers with stronger balance sheets, such as Sunac China Holdings, China Vanke and Country Garden Holdings, have held up so far, although stock values have fallen 17% to 26. % last month. Bonds issued by China Minsheng Bank, which has the largest exposure to Evergrande, fell briefly below par this month but quickly regained their value.
However, a default in the real estate sector could still have significant consequences. It could hurt consumer confidence if people lost deposits for houses that have yet to be completed, or if it cripples suppliers and contractors who are large employers. This, in turn, could exacerbate defaults across the banking industry.
The Chinese economy stuttered in August, affected by pandemic measures and restrictions on home loans. Retail sales growth last month slowed to 2.5% from a year ago, and home sales by value fell 20%, the biggest drop since the start of last year , when the onset of the pandemic resulted in a lockdown.
Investment in construction, meanwhile, contracted 3.2% in the first eight months of the year.
“If Evergrande’s problems continue for a long time, it will erode the confidence of homebuyers and investors as they try to see who will be next,” said Michelle Lam, Greater China economist at Societe Generale. “Although our central scenario does not project any risk to the financial system, the whole episode of Evergrande could harm the economy and the real estate sector at large unless the government relaxes the debt rules. immovable.”