Evergrande Group, once the world’s largest real estate empire and now its most indebted company, is teetering. China’s authorities will be acutely aware that if it falls, it could bring down its increasingly vulnerable property market and ignite a financial crisis.
At the weekend, hundreds of investors - mainly its own employees - protested at Evergrande’s Shenzhen headquarters and other offices in China, demanding redemption of their investments in the company’s wealth management products after the group failed to make interest payments and meet withdrawals.
As an indication of how parlous the group’s situation is, it is offering to either repay 10 per cent of their interest and principal quarterly, or to exchange the debt for property assets.
On Tuesday, in a statement to the Hong Kong Stock Exchange, Evergrande detailed the extraordinary pressures mounting on the group, which has about $US89 billion ($122 billion) of debt and more than $US300 billion of total liabilities.
Evergrande, which has about 1300 developments in 280 Chinese cities and more than a million buyers waiting to move into their apartments, relies on presales of its apartments for its cash flows.
It has been experiencing an accelerating decline in the sale of its properties, which it expects to continue this month – usually a very strong month for sales -- “thereby resulting in the continuous deteriorations of cash collection by the group, which would in turn place tremendous pressure on the group’s cash flow and liquidity.“
The fate of Evergrande has massive implications for China’s already shaky property market and the economy-at-large, with property sales accounting for close to 10 per cent of China’s GDP and property constituting the vast bulk of households’ wealth.
Evergrande has been trying to sell assets to generate liquidity and reduce its debt but, after some initial success – it had raised more than $US2 billion this year – that program has stalled.
Its latest statement said there had been no material progress in the efforts to sell its interests in what was once the world’s most valuable electric vehicle manufacturer (whose value has crashed about 95 per cent from its peak), its property services business and its Hong Kong offices.
“In view of the difficulties, challenges and uncertainties in improving its liquidity...there is no guarantee that the group will be able to meet its financial obligations under the relevant financing documents and other contracts,” it warned.
“If the group is unable to meet its guarantee obligation or to repay any debt when due or agree with the relevant creditors on extensions of such debts or alternative agreements, it may lead to cross-defaults under the group’s existing financing arrangement and relevant creditors demanding acceleration of repayment.
“That would have a material adverse effect on the group’s business, prospects, financial condition and results of operations,” Evergrande’s statement said.
Staring into the abyss
Evergrande has about $US129 million of interest payments due on its offshore bonds this month alone, and faces bond redemptions of $US3.5 billion in March and April next year.
It’s now staring into the abyss, with the apartment pre-sales it relies on for cash flows drying up rapidly – on the current trend they will have more than halved between June and September – and no access to debt markets after a crash in the value of its bonds to less than 30 per cent of their face value.
The company has appointed financial advisers, Houlihan Lokey (regarded as one of the world’s best corporate restructuring specialists) and Admiralty Harbour Capital to “explore all feasible solutions to ease the current liquidity issue.”
Major “haircuts” - or a total wipe-out – for holders of its debt securities appear near-certain.
The fate of Evergrande has massive implications for China’s already shaky property market and the economy-at-large, with property sales accounting for close to 10 per cent of China’s GDP and property constituting the vast bulk of households’ wealth. If suppliers are included, the overall contribution of the real estate sector to the Chinese economy is probably closer to 30 per cent.
Evergrande alone has relationships with more than 128 banks and 120 non-banks. With impairments on property loans surging after the authorities tightened credit for property development last year, defaults on its loans could trigger a wave of stress throughout the rest of the sector and its suppliers.
China’s authorities are caught between a rock and a hard place. For four years they have been trying to deleverage the economy, a process interrupted last year by the pandemic but subsequently resumed.
They introduced specific caps on leverage for property developers – the “three red lines” that cap balance sheet and liquidity ratios -- limited the ability of the companies to add new debt and began rationing the amount of credit banks could make available to the sector.
They may have underestimated the vulnerability of the sector – the Evergrande experience says there is significant off-balance-sheet funding via “wealth management” products – but, in any event, the efforts to deflate a leveraged property bubble may have been too successful.
Authorities won’t want Evergrande to fail because of the potential for it to trigger a wider collapse, a property-related financial crisis and social and political stress.
Equally, they have been reluctant to bail out distressed companies, conscious of the moral hazard that creates - even though they have recently been forced to rescue their big partly state-owned bad debt manager, Huarong.
A restructuring of Evergrande that essentially wipes out its bond holders while, with some state involvement, protecting suppliers, customers and the state-owned banks with big exposures would appear the most likely outcome.
China’s new governing mantra of “common prosperity” has already demonstrated a lack of concern for losses incurred by private shareholders and bond holders.
Authorities’ salvaging of what’s important to them of Evergrande as they try to contain the damage from its implosion is unlikely to be any different.