Commentary on Political Economy

Wednesday 7 July 2021


China Bubble About To Burst

Evergrande’s $32 Billion of IOUs Add to Liquidity Concerns

 Updated on 
    Embattled developer ramps up commercial bill issuance
    Implied yields on some bills have climbed as high as 36%
Bloomberg Markets: The Close (07/07/2021)
WATCH: China’s most leveraged real estate company, China Evergrande Group, is ramping up issuance of short-term IOUs. 

As China Evergrande Group tries to quell concerns about its financial health, the property giant has gone to great lengths to publicize its shrinking debt load.

What the developer rarely mentions, however, is that it’s also ramping up issuance of short-term IOUs. While not technically classified as debt, Evergrande’s growing reliance on such financing -- known in China as commercial bills -- suggests the company faces mounting liquidity pressure as banks and bond investors increasingly shy away from providing it with longer-term funds.

Evergrande’s main onshore subsidiary had about $32 billion of commercial bills outstanding as of December, the most of any major Chinese real estate company. Some bills issued by its units are now trading in the secondary market at implied yields as high as 36%, after a series of missed payments this year. By comparison, Evergrande dollar bonds due 2025 yield about 25%.

“The amount of Evergrande’s outstanding commercial bills is massive,” said Dong Ma, a Beijing-based partner at BG Capital, which specializes in high-yield bond investments. “It has apparently become a vital fundraising channel.”

Evergrande’s turn toward short-term funding casts doubt on whether its widely touted deleveraging campaign has actually made its finances more sustainable. Even as the debt line item on its balance sheet has shrunk, total liabilities -- which includes commercial bills and other short-term payables -- grew to a record 1.95 trillion yuan ($301.6 billion) last year.

While Evergrande has said it will make good on all its overdue payments, any sign the company is struggling to follow through could lead to a broader freeze in China’s $560 billion-plus commercial bill market.

Missed payments would also weigh on Evergrande’s vast network of suppliers, which are among the biggest holders of the developer’s IOUs and have less scope to absorb losses than banks. Those risks could add pressure on Chinese authorities to provide support for Evergrande, though any such decision would likely be weighed against the government’s desire to rein in moral hazard.

Evergrande Dwarfs Peers

Outstanding commercial bills of China's top 10 developers by sales in 2020

Source: Company filings

Note: Excludes China Resources Land, which doesn't have breakdown on commercial bills 

“If Evergrande has serious payment difficulties, it would have a sweeping impact across the whole industry chain,” said Yan Yuejin, research director at Shanghai-based E-house China Research and Development Institute. “Lots of small suppliers’ liquidity would be affected.”

Evergrande, whose shares dropped 1.7% to a four-year low on Thursday, didn’t reply to a request for comment. The developer cut its total borrowings to about $88 billion in late June, down 20% since the end of last year. That allowed it to meet one of China’s “Three Red Lines” for property developers, metrics that determine whether the companies can take on additional debt.

100% cap on net debt to equityMet in late June
Cash to short-term debt ratio of at least oneDec. 2021
70% ceiling on liabilities to assets, excluding advance proceeds from projects sold on contractDec. 2022

While Evergrande’s debt declined in the first half, its payables -- including commercial bills -- probably continued to increase, according to Zhou Chuanyi, an analyst with Lucror Analytics. The company’s total trade and bills payables rose 14% to 622 billion yuan last year, according to Fitch Ratings, which downgraded Evergrande’s credit rating by one notch to B in June.

China Chengxin International Credit Rating Co., the country’s largest credit risk assessor, added Evergrande’s onshore unit Hengda Real Estate Group and nine of the company’s onshore bonds to a watch list in June, partly due to concerns over past-due commercial bill payments.

Commercial bills have become a popular financing tool in China’s real estate industry, which has become subject to a growing number of borrowing restrictions in recent years.

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Bills come in many different forms, often depending on the specifics of a developer’s relationships with suppliers. In situations where the developer has a stronger bargaining position, it might agree to simply postpone immediate payment for a service without providing extra compensation. In other cases it may offer a sweetener, for instance by paying a supplier 1.1 million yuan in six months for 1 million yuan worth of services rendered today.

Suppliers can sell their bills in the secondary market, where prices reflect market perceptions of creditworthiness. When bills trade at steep discounts to face value (or high implied yields), it suggests mounting concerns about repayment risk.

Implied rates on some of Evergrande’s units are far higher than the 10% to 20% range typically seen for Chinese property companies, according to Essence Securities, a Chinese brokerage. Rates on Evergrande bills have been climbing in recent years, particularly after the developer faced a major liquidity scare in September, according to bill holders.

Unlike investors in bonds and preferred shares who enjoy some priority in claiming assets, bill holders have little means to claim their payments upon a default. That’s partly why China’s central bank is asking some property developers to disclose their outstanding commercial bills monthly to regulators, local Chinese media reported in June.

It may also be why some holders of overdue Evergrande bills have become increasingly vocal as they try to pressure the developer to pay up.

Shanghai-listed Skshu Paint Co. said in a June 28 exchange filing that it held 51 million yuan in overdue bills owed by Evergrande units as of March 31 and that only 4% of the total was recovered by May 31.

Just a day after Skshu released the filing, it said Evergrande had repaid the bills in full.

“Commercial bills have previously gone largely unnoticed,” said Yan at E-house China Research. “But that is changing.”

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