‘Biggest fraud in China’s history’: Are evergrande’s debts safe?

Written by Dada Brackenbury, CNN Chinese property developer Evergrande Group faces a heavy debt load of $24 billion. More than half of that amount is owed to China Development Bank, a shadow bank specifically…

'Biggest fraud in China's history': Are evergrande's debts safe?

Written by Dada Brackenbury, CNN

Chinese property developer Evergrande Group faces a heavy debt load of $24 billion. More than half of that amount is owed to China Development Bank, a shadow bank specifically targeted by the country’s central bank for lending excess cash.

The company’s ability to pay this debt is precarious, but Friday saw the payment made in full. This is the second time a senior Evergrande debt payment has been paid off, enabling the company to avoid defaulting on bond obligations, according to China’s most prominent bond market watcher, Zheshang Securities.

This recent debt pay off comes after a difficult year for Evergrande: the company filed for bankruptcy protection in May after its borrowings exceeded its cash flow. A $3.5 billion restructuring of its debt will help the company emerge in September.

However, Evergrande’s troubles are far from over. The company faces three more important bond payments this year, one in October, then in November and in December. Additionally, the company’s ratings are heavily scrutinized, as it will see the largest decline in profitability in the country over the next three years, according to research from Renaissance Capital.

Bondholders need a strong margin between their bond payments and profitability. After all, if Evergrande fails to pay off this debt, China’s central bank will likely increase interest rates to curb credit growth and bring Evergrande back under control.

Long-term loans are especially risky: Evergrande has over $20 billion in “long-term borrowings” according to state media outlet Xinhua. Overall, China’s largest banks are heavily indebted — they owe $19 trillion, and nearly half of that debt is unpaid.

According to Brackenbury, Moody’s Investors Service does not expect the outcome of China’s current debt deleveraging to directly affect the balance sheets of equity or bondholders of Chinese debt-laden companies. “But should the government take an aggressive stance and forced capital transfers and debt restructuring…that could weigh heavily on an unrated, high debt company like Evergrande,” she said.

Ruling party pushes ahead with ‘risk management’

China’s anti-corruption drive has further drained liquidity from the country’s financial markets in recent months. Several major companies announced that they were preparing to sell treasury bonds in the market, and the insurance regulator decreased the daily turnover cap of futures in gold.

To prevent this from escalating into an asset bubble, China’s government has been pushing a “risk management” strategy this year. The Chinese securities regulator also launched new voluntary guidelines for shadow banking, requesting banks to set aside more capital against “simple, unspecialized, high-risk loans.”

Many of the country’s companies are complex derivatives instruments. In fact, Brackenbury notes that roughly 50% of the equity market in Shanghai and Shenzhen is debt-equity synthetic financing linked to one another. “It’s largely misaligned capitalization and leverage that has created so much tension in the market, and the crowding out of Chinese retail investors at the point of sale and so on,” she said.

What’s happening with the country’s property market?

Just when Evergrande seemed to be reaching the end of the crisis, an uptick in Chinese property markets earlier this year seems to have turned a corner. Shanghai just reported the strongest year-on-year uptick in sales and contracts in June since August 2016.

This prompted a new spate of high-profile stock falls this week. Following a drop of 7% on Wednesday, China’s HNA Group was down 16% Thursday afternoon. Analysts warned that tighter monetary policy measures, after a period of easing, are being rolled out by the government, attempting to pressure Chinese companies out of their overheated property markets.

But whether that will yield a silver lining is impossible to say, considering China’s building boom has never ended.

Leave a Comment