Households risk becoming victims of the investment debacle and the Chinese government is concerned about preserving financial stability.
Tens of thousands of Chinese households risk being sucked into the spectacular unravelling of China Evergrande Group after the embattled developer missed payments on investment funds sold through shadow banks, which have funnelled billions into its construction projects.
Some of these lenders, known as trusts, have already dipped into their own pockets to repay wealthy investors on Evergrande’s behalf, according to people familiar with the matter.
Others are reported to be negotiating payment extensions with Evergrande. It’s not clear how much of the funds are in arrears and there’s no evidence that trusts are passing payment delays on to customers who bought fixed-income products tied to Evergrande.
Already, missed payments on 40 billion yuan ($8.5 billion) of wealth products sold by Evergrande itself to retail investors have sparked nationwide protests, putting more pressure on Beijing to find a solution and avoid further unrest.
Contagion into the $4.1 trillion trust industry will put at risk many more investors, while also threatening the biggest source of non-bank funding for the property sector as shadow banks retreat.
“The Chinese government will place social stability as one of the priorities,” says James Feng, the founding partner of Poseidon Capital Group, a Chinese fund that specialises in distressed and special situation investments.
The clock is ticking for Evergrande to make these investors whole.
The cash-strapped firm faces repayments in the fourth quarter on $2.47 billion of high-yield products sold through trusts to wealthy clients and institutions. Another $5.5 billion is due next year, according to data provider Use Trust.
In a recent meeting, regulators urged the company to complete unfinished housing projects and repay retail investors, while averting a default on its dollar bonds.
Evergrande’s billionaire chairman Hui Ka Yan told staff last week that buyers of its investment products would be repaid, the company says.
Yet with more than $412 billion in liabilities and cash flow shrinking, it’s not clear how Hui can pull that off. The company already missed a September 23 deadline to make an $114.6 million coupon payment on a $2.74 billion bond maturing in March.
The firm is also subject to heightened restrictions on its bank accounts as regulators ensure it uses cash to complete housing projects and not to pay creditors. The stock and bonds are reeling.
Evergrande’s dependence on trusts and other asset management products began growing after banks were directed to cut back on their lending to the property sector.
In response to Evergrande’s financial troubles, the trust firms grew more cautious last year, with some accepting only one of dozens of proposals from the developer, often funding less than half the project value.
Trusts are also reducing their exposure to other property firms, a sign that Evergrande’s woes threaten the entire real estate industry, which accounts for more than 15 per cent of China’s economy. The trusts have cut outstanding loans to property firms by $42.7 billion in the first half of this year, a drop of 17 per cent, according to the trust association.
Despite this, trusts remain Evergrande’s biggest source of direct debt, outweighing bank borrowings and bonds, says Christopher Yip, a senior director at S&P Global Ratings. “They are also the biggest trust borrower in the property sector.”
When trusts began pulling back, the developer started squeezing money from more murky sources – selling its own high-yield wealth products to staff, homebuyers and others. To side-step regulations and keep borrowings off its books, the money wasn’t raised in Evergrande’s name, leaving some analysts to speculate on whether there are hidden obligations that are yet to surface.
Evergrande didn’t shy away from aggressive sales tactics. As the stock and bonds began to crater this year, it sent out a directive to employees: find buyers for the company’s high-yield investment funds or your job could be at risk.
Many staff complied, not only buying the products for themselves, but encouraging friends and family to do the same.
An employee promotion sent to workers in Liaoning province in July had these investment goals: $21,252 per employee, up to 10 times that for executives. Managers would be rewarded – or fined – based on meeting the targets, and the purchases would be “important evidence” of performance, according to a memo seen by Bloomberg News.
Two months later, angry employees and investors joined protests after the developer failed to make payments on the products, some of which offered yields as high as 10 per cent.
One fund investor, who identified himself as Mr Hu, rode a train for 20 hours in a hard berth seat to join protesters outside Evergrande headquarters in Shenzhen.
The hardware factory worker from Henan province initially invested $21,252 after being pitched by Evergrande staff. When the 7 per cent fund paid off, he took out a loan to boost his investment to $170,021. Hu, 31, worried he won’t get his money back, says he is willing to stay in Shenzhen until he does.
“Even if I go home now, I can’t sleep well and eat well,” he says. “I might as well stay here and support other protesters.”
Hui, at one time one of China’s richest people, set up a separate investment unit known as Evergrande Wealth in 2015 to seek new funding sources for his sprawling businesses that range from condominiums to electric vehicles and bottled water.
Evergrande Wealth is known as an independent wealth manager, which is among the least regulated corners of China’s sprawling shadow banking system. Largely untouched by a government clampdown on most forms of non-bank financing, the industry has grown into a major source of funding for cash-strapped Chinese companies by selling high-yield products to affluent investors.
Evergrande capitalised on the loose regulations, selling the funds to some 70,000 retail investors even though these debt instruments, known as private publication notes, are usually intended for institutional investors or individuals with at least 1 million yuan to invest.
Evergrande didn’t respond to requests for comment.
The high-yield products have raised red flags from regulators in the past. Banking watchdog chairman Guo Shuqing has warned that if any product offers a return above 6 per cent, it should raise questions. If it’s higher than 8 per cent, it’s dangerous, and if it tops 10 per cent, investors should prepare to lose every penny.
To be sure, the trust funds are closely regulated and there have been no signs of investor protest yet, unlike Evergrande’s other wealth products.
Anger about the missed payments on the Evergrande funds bubbled over this month as some investors vented on social media while others trekked to Evergrande’s glass-tower headquarters.
There they were greeted by a dozen police officers and security guards in riot gear brandishing plastic shields.
One investor, Mr Wang, had been in Shenzhen for two days, saying he couldn’t bear to tell his elderly parents what had happened. He didn’t care about the interest payments and was just hoping to get his $21,252 investment back.
When asked about the company’s repayment options, including discounted properties or deferred cash over 30 months, Wang just muttered along with his friend, “It’s a fraud.”