China Evergrande Group, one of the biggest Chinese property developers, is like a terminally ill patient spreading an epidemic through China and beyond China. If the world’s most indebted property firm collapses, it could wreak severe damage to China’s economy and ripple throughout the wider Asian economy, so the Chinese government is expected to prevent a hard landing of the collapsing conglomerate, analysts predict.
On September 7, Moody’s and Fitch downgraded Evergrande to levels of near default. A Fitch report said, “the downgrade reflects our view that a default of some kind appears probable.”
A default by the Hong Kong-listed firm is likely, concurred S&P Global in a September 20 report.
“A complete default of Evergrande would cause massive instability in China’s entire property market and could lead to the “Minsky Moment” for the economy, where a rapid fall in asset prices would force the rapid deleveraging of the financial system,” Andrew Collier wrote in a report by Global Source Partners, a US macroeconomic research firm, on September 14.
Even though Evergrande is not a state firm, it is “too big to fail” and is important to the integrity of the Chinese property market, wrote Collier, a managing director of Orient Capital Research. “Therefore a debt workout is on the cards – but it is unlikely to be a direct bailout by the central government. Beijing would like to give the appearance of distancing itself from a private property developer.”
Evergrande is a systemic risk because it has around 1 million retail clients through mortgages on its properties. 71 percent of its US$300 billion in debt comes from financial institutions and it is the largest single issuer in China’s US$1 trillion offshore bond market, Collier explained.
In a tweet on September 21, Paul Krugman, a US economics Nobel laureate, said even if Evergrande’s problems are contained, “hey, remember when people said that about subprime?”, referring to the US subprime property loan crisis that precipitated the global financial crisis in 2008. Evergrande may be the leading edge of bigger problems, suggested Krugman.
Giving the opposite view, US Federal Reserve chairman Jerome Powell said on September 22 that Evergrande’s debt problems seem particular to China and that he did not see a parallel with the US corporate sector, as reported on several television programmes including Bloomberg TV.
The S&P report from September 20 said, “Events could broadly rattle investors' confidence in China's property sector and for speculative-grade markets broadly... Evergrande's difficulties are also weighing on China's property market. This could have wide-reaching negative ramifications for other developers, suppliers and contractors, and the banks and financial institutions that lend to them.”
As of the middle of this year, Evergrande’s trade payables were nearly RMB700 billion (US$108 billion), its offshore bonds outstanding totalled roughly RMB130 billion and its onshore bonds outstanding totalled roughly RMB60 billion, estimated S&P.
S&P on August 9 downgraded E-House (China) Enterprise Holdings, a Hong Kong-listed property services firm, due to possible delayed payment of bills by Evergrande. On September 21, S&P downgraded Sinic Holdings (Group), a Hong Kong-listed property developer to CCC+, indicating vulnerable business risk and high debt but a default is not yet on the horizon. The previous day, Sinic’s share price plunged 87 percent then suspended trading.
“Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy. Evergrande failing alone would unlikely result in such a scenario,” the S&P report predicted.
Alicia Garcia-Herrero, Asia Pacific chief economist of Natixis, told FinanceAsia, “Evergrande is bound to affect China’s real estate developers more than Asia’s dollar bond market, although there will still be jitters in the high-yield space given Evergrande’s size and also the general size of Chinese developers in Asia’s dollar markets.”
The global impact will be much more muted because Evergrande does not have a global presence and the real estate market in China remains very much local, Garcia-Herrero qualified.
“Evergrande's problems are affecting other weaker Chinese real estate companies and will affect investor confidence in buying Chinese corporate bonds. People are not going to buy Chinese wealth trust products as easily as before,” a senior finance executive based in Hong Kong and Europe told FinanceAsia.
Numerous sectors could be exposed to heightened credit risk if Evergrande were to default, Fitch Ratings said in a report on September 14. “We believe a default would reinforce credit polarisation among homebuilders and could result in headwinds for some smaller banks, although we believe the overall impact on the banking sector would be manageable.”
“Smaller (Chinese) banks with higher exposure to Evergrande or to other vulnerable developers could face significant increases in non-performing loans (NPLs),” Fitch warned.
A Natixis report on September 15 said, “a key question is whether the fall of Evergrande will trigger a domino effect and pose systemic risks. The answer is systemic risks will be avoided in the run-up to the 2022 Party Congress (in October or November) given its historical importance.”
“However, this would also imply China Evergrande's debt crisis may snowball down the road considering economic growth will not be here to awash financial losses as was the case in the past. The most likely scenario is Evergrande may be forced to sell assets at a discounted price, but finding a white knight will be challenging given the large corporate size,” the Natixis report said.
In China, the spreads for private firms between real estate and other sectors have widened not only in the offshore market but also onshore, said a Natixis report on September 10. “This shows even onshore investors are worried on the financial health of some (Chinese) private property developers.”
The offshore bond yield of Chinese property companies excluding Evergrande was roughly 10 percentage points higher than that of other sectors in China in early September, double the gap in the middle of this year, according to data by Natixis and Bloomberg. With Evergrande included, the offshore bond yield of Chinese property developers was about 12 percentage points higher than those of other sectors in China in early September, up from roughly 5 percentage points in the middle of this year. The onshore bond yield of Chinese property firms both including and excluding Evergrande exhibited similar widening in spreads over other sectors, according to the data.
From September 15 to 21, the Hang Seng Properties Index fell 8.9 percent. Evergrande’s share price of HK$2.27 on September 21 represented a greater decline of 22.5 percent over the same period and was 84 percent lower than its share price of HK$14.14 on January 4.
However, Evergrande’s share price leapt up 17.6 percent to HK$2.67 on September 23, after Evergrande’s subsidiary Hengda Real Estate Group said in an announcement on the Shenzhen Stock Exchange website on Wednesday that it would make interest payments on some of its onshore Chinese bonds.
On September 23, a Hong Kong-listed property developer, China Estates Holdings, disclosed that it had sold 108.9 million shares of Evergrande or a 0.82 percent stake from August 30 to September 21.
“The directors are cautious and concerned about the recent development of China Evergrande Group including certain disclosure made by (the company) on its liquidity” stated the disclosure.
