As the deadlines for Evergrande’s overdue bond payments edge closer – and the Chinese property group heads for official defaults – the fallout is expected to have an impact on the rest of China’s property market and investor confidence in the sector.
The Chinese property group Evergrande is widely expected to officially default on its overdue bond payments when the 30-day grace period – which was initiated when the group missed payments at the end of September – comes to an end. As the world’s most indebted property group, with approximately US$300bn of debt, investors are bracing themselves for the fallout and are speculating how far the ripples – or tidal wave – of defaults will be felt.
Other property groups in China are also heading for defaults on their bonds, while others have been downgraded by ratings agencies. And for property companies that are in good shape, they risk being tarred with the same brush and being negatively impacted by the changing investor sentiment, finding it challenging to raise funds in the debt markets.
“The problem for China, and by extension for worldwide finance is that Evergrande’s difficulties may be typical of many Chinese companies. The picture is, after all, common among companies in any fast-growing economy such as China has had until recently,” Milton Ezrati, Chief Economist at Vested, wrote in a blog post.
Property company Modern Land (China) has asked for an extension on an upcoming bond payment and Fantasia Holdings has already missed a payment deadline. And other firms – including Sinic Holdings, R&F; Properties, Xinyuan Real Estate, Central China Real Estate and Risesun Real Estate Development – have all been downgraded.
It remains to be seen whether Evergrande will officially default on its bond payments. It has so far missed a US$47.5m payment and a US$83.5m payment, which was due in September, and is now in a grace period which will end later this month. Another bond payment is due later in October and there are also payments on offshore bonds that are due before the end of the year.
There has been speculation about whether the Chinese government will allow Evergrande to default, or whether it will step in with a rescue package. A recent report by S&P; Global Ratings argues that the state would only step in if there was widespread contagion in the market. “Evergrande failing alone would unlikely result in such a scenario,” the analyst report states.
The potential fallout has been likened by some to China’s Lehman moment. F0r example, CNBC quoted Mark Williams, Chief Asia Economist at Capital Economics, as saying, “Evergrande’s collapse would be the biggest test that China’s financial system has faced in years”. Banks that have lent to the group – and its creditors – are likely to be affected, and also some commentators have said that it is unknown who is actually exposed to Evergrande.
On the question on whether there will be a tidal wave or a ripple of defaults, ratings agency S&P; Global Ratings states in the analyst report that it will be somewhere in between.
Also, when compared to other property groups, S&P; explains how it is different from other companies: “Evergrande’s contracted sales have fallen more than other issuers in the sector that have experienced distress.” Most large Chinese developers, the report notes, were able to continue operating even after defaulting, whereas Evergrande’s business has been slowing significantly.
The reason for this, the report states, is that Evergrande relied heavily on supplier commercial bills for its working capital and debt needs. “From what we understand, the commercial bills have a more rigid repayment date. The instruments are tradable in nature and may have changed hands multiple times. Suppliers and contractors that have gone unpaid have filed lawsuits against Evergrande and have managed to freeze assets, rejecting any further bills as payments. This had led to substantial halts in project construction, hitting Evergrande’s sales and creating concerns about its ability to deliver projects,” the report notes.
