Is The World’s Most Indebted Developer Too Big To Fail?

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With a flurry of announcements that sent Evergrande bonds tumbling to record lows this week, the company and Beijing have made it clear that billionaire Hui Ka Yan’s property giant is headed for one of China’s largest-ever debt restructurings, reports Bloomberg.

 The lengthy battle

Barring a last-minute shock, holders of $19.2 billion in Evergrande dollar notes face deep haircuts as the company overhauls its mammoth balance sheet without a government bailout — a process that promises to be long, contentious and potentially risky for Asia’s largest economy.

While ratings companies have yet to declare an official default, holders of two bonds issued by an Evergrande unit hadn’t received overdue coupon payments by the end of a 30-day grace period on Monday. S&P Global Ratings said on Tuesday that a default by the developer was “inevitable.” Evergrande didn’t immediately respond to a request for comment.

The developments mark the beginning of the end for the sprawling real estate empire started 25 years ago by Hui, setting off a lengthy battle over who gets paid from what remains. Evergrande said in a brief exchange filing on Friday that it plans to “actively engage” with offshore creditors on a restructuring plan. The company is planning to include all its offshore public bonds and private debt obligations in the restructuring, people familiar with the matter said Monday.

Victim of Xi

Evergrande, which disclosed more than $300 billion of total liabilities as of June, becomes the biggest victim of President Xi Jinping’s efforts to crack down on the free-wheeling real estate sector and curb property speculation. Beijing’s reluctance to bail out the developer sends a clear signal that the Communist Party won’t tolerate massive debt build-ups that threaten financial stability.

The question now is whether the government can limit the fallout. The bonds of smaller, lower-rated real estate firms have plunged in recent weeks, driving yields above 20%, though they were poised for a second day of gains Wednesday as Beijing’s easing signals injected confidence into the market.

Own poor management 

For now, Chinese authorities are signaling that they plan to ring-fence Evergrande and limit contagion rather than orchestrate a rescue as they’ve done during past crises.

The People’s Bank of China reiterated on Friday that risks posed to the economy by Evergrande’s debt crisis can be contained, citing the developer’s “own poor management” and “reckless expansion” for the problems it faces. The China Banking and Insurance Regulatory Commission said in a separate statement that loans for real estate development and acquisitions should be issued in a “reasonable” manner.

The latest financial system support measures came on Monday, with China’s central bank releasing about 1.2 trillion yuan ($188 billion) of liquidity via a cut in the reserve requirement ratio for most banks. The government pledged to support the housing market to better meet “reasonable” needs, adding to signs it will ease real estate curbs.

The extreme stress

In all, Chinese borrowers have defaulted on a record $10.2 billion of offshore bonds this year, with real estate firms making up 36% of that total, according to data compiled by Bloomberg.

“There is extreme stress in the market,” with about half the developers in the country in deep financial distress and pricing in high default risk, said Jenny Zeng, co-head of Asia Pacific fixed-income at Alliance Bernstein.

China is also trying to limit the fallout on the broader housing market, in a country where real estate accounts for about a quarter of economic output and as much as 75% of household wealth. China’s housing slump has intensified in recent months after sales plunged and home prices fell for the first time in six years.

Contract sales by the country’s top 100 developers plunged 38% in November from a year earlier to 751 billion yuan, sharper than the 32% drop in the previous month, according to preliminary data from China Real Estate Information Corp.

Global growth 

Any slowdown in real estate could have a ripple effect not only on China’s economy but on global growth. China’s growth slowed in the third quarter, with signs there will be more pain to come. The Federal Reserve last month warned that fragility in China’s commercial real-estate sector could spread to the U.S. if it deteriorates dramatically. China’s real estate sector makes up almost half of the world’s distressed dollar-denominated debt.

“Think about the cyclical risk out there if we lose China,” Ark Investment’s Wood said at a recent Milken Global Conference. “At the margin, China has been responsible for a tremendous amount of cyclical growth.”

China’s government isn’t standing pat. President Xi oversaw a meeting of the Communist Party’s Politburo on Monday that concluded with a signal of an easing in curbs on real estate. The leadership panel, gathering in advance of a broader annual economic session that sets goals for the coming year, pledged to stabilize the economy in 2022.

Evergrande’s dollar notes

With Evergrande’s dollar notes trading at about 20 cents on the dollar, the market is already pricing in a haircut of around 80%. The key for bondholders is whether the company can speed up home sales and unload assets to raise cash so it can start settling its liabilities, said Gary Ng, a senior economist at Natixis SA.

Further market reaction to Evergrande’s missed payments may be driven by how the restructuring process plays out, said Jim Veneau, head of Asian fixed income at AXA SA.

“An orderly restructuring, where the company can run its operations as normally as possible and refrain from distressed asset sales will substantially help contain further damage across the sector,” Veneau said.

The single biggest loser in dollar terms may be Evergrande founder Hui, who once owned more than 70% of the company before recent stock sales. The plunge in Evergrande’s share price this year has cut the chairman’s wealth by 73%, or about $17 billion, according to the Bloomberg Billionaires Index. Once the second-richest man in China, Hui now ranks 75th.

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Source: Bloomberg

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