The troubled Chinese property group Evergrande has edged closer to a government-engineered restructuring which could see bondholders take huge losses as Beijing’s price for saving millions of homeowners from financial ruin.
With the likelihood increasing every day that the massively indebted group will be dismantled to avoid triggering a market-wide panic, trade in one of its bonds was suspended in Shanghai on Monday after it plunged 25%.
Shares in the group founded by billionaire Xu Jiayin in the 1990s slipped 6% on Monday to sit below their 2009 float price of HK$3.5.
Evergrande has been struggling to manage its enormous $300bn debt pile for several years but tougher regulations about debt levels brought in last year as part of president Xi Jinping’s drive against inequality has accelerated its crisis. A firesale of its properties has failed to dent the debt pile despite generous discounts, a strategy further undermined by falling house prices.
The property market has exploded in China in the past two decades. Total real estate sales were 16tn yuan ($2.5tn) in 2019, of 10% of the country’s entire economic output.
A disorderly failure of Evergrande would represent a serious risk to the whole Chinese economy, with the risk of contagion in the rest of the world.
Another sign of the weakness of the sector came when shares in the office developer Soho Sjina tumbled 35% on Monday – its biggest daily drop since listing more than 14 years ago – after the US investment giant Blackstone scrapped a $3bn takeover deal.
Economists at the consultancy Capital Economics said in a note titled “Evergrande circling the plughole” that a banking failure triggered by the collapse of major property developers was the “single most likely scenario that could lead to a hard landing in China”.
Nomura International Hong Kong credit analyst Iris Chen told Bloomberg on Monday that a restructuring of the group was “almost unavoidable”. She believes that the government in Beijing will ensure that Evergrande delivers homes and pays suppliers, where dollar debt investors would get 25% of their money back.
Luther Chai, a senior research analyst at CreditSights Singapore, also said Evergrande will default and enter restructuring. Evergrande’s dollar bonds are trading at around 30c in the dollar, which indicates losses of 70%. Foreign investors own $7.4bn of Evergrande’s US-denominated debt.
Mark Williams, chief Asia economist at Capital, also believes that the most likely endgame is “a managed restructuring in which other developers take over Evergrande’s uncompleted projects in exchange for a share of its land bank”.
Capital estimates that Evergrande had 1.3tn yuan in presale liabilities at the end of June, equivalent to roughly 1.4m individual properties that it has committed to complete. “A restructuring that prioritised homebuyers might not leave much for other creditors,” Williams said, pointing to heavy losses for bondholders.
Xi seems determined to target some of China’s billionaires in his drive to create a more equal society, as Alibaba founder Jack Ma found to his cost last year. In a harbinger of the “three red lines” introduced to toughen up balance sheet requirements for property firms, Xi said two years ago that houses were for “living in, not for speculating”.
Evergrande was the “poster child for excess leverage in a sector in which policymakers want to instil more discipline,” Williams said.
Ben Wang, of Jamieson Coote Bonds in Sydney, also agrees that the default is coming. “Given the large size of its balance sheet, Evergrande is deemed as a systematic risk to the Chinese financial system: the authorities cannot afford to let it fail abruptly. We believe Evergrande is likely to collapse in a controlled manner.”
Evergrande said two weeks ago that its total liabilities had swelled to 1.97tn yuan ($305bn) and warned of risks of defaults on borrowings.
It issued a profit warning at the end of August in which it admitted that it could default on debt payments. The warning came days after Xu, the third richest person in China, resigned as chairman of its real estate arm.