EXPLAINER-How China Evergrande’s Debt Problems Pose Systemic Risk

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HONG KONG, July 27 (Reuters) – Financial woes at China’s most indebted real estate developer, China Evergrande Group, have sparked new concerns over credit defaults in the country’s heavily indebted real estate sector and wider contagion.

The developer has not defaulted on interest payments, but concerns persist about its financial health as Beijing steps up restrictions on the sector to contain bubble risks. Evergrande shares have lost 65% since last September, when sources told Reuters they asked the government to help it avoid a cash shortage.

S&P downgraded its Evergrande ratings two notches to B- versus B + on Monday, further weakening its access to financing and raising doubts about its ability to reduce debt.

WHO IS EVERGRANDE?

Founded in 1996 by President Hui Ka Yan in the southern city of Guangzhou, Evergrande has accelerated its growth over the past decade to become China’s second-largest real estate developer with $ 110 billion in sales last year.

The company was listed in Hong Kong in 2009, giving it better access to the capital and debt market to increase its asset size to $ 355 billion today. It has more than 1,300 developments across the country, many in lower-tier cities.

With domestic sales growth slowing in recent years, Evergrande has also branched out into non-real estate businesses, such as electric cars, football, insurance and bottled water.

HOW DO CONCERNS ARISE ABOUT DEBT?

Investors became concerned after a letter leaked in September showed Evergrande sought government support to approve a now-abandoned backdoor listing plan, warning it was facing a cash shortage.

Concerns escalated after Evergrande admitted in June that it failed to pay certain commercial bills on time, and a Chinese court last week froze a $ 20 million bank deposit held by the company. at the request of Guangfa Bank.

Evergrande’s rapid expansion over the years has been fueled by debt. It aggressively raised loans to support its land-buying frenzy and sold apartments quickly despite low margins to kickstart the cycle.

The company said its interest-bearing debt stood at 570 billion yuan ($ 88.2 billion) at the end of June, from a peak of 835.5 billion yuan a year earlier as it stepped up its operations. debt reduction efforts.

Total liabilities, which include debts, however, stood at 1.95 trillion yuan at the end of 2020, representing 10.5% of the total liabilities of 45 real estate developers, ANZ estimated in a report.

In addition to the usual banking and bond channels, the developer has come under fire for tapping into the less regulated shadow banking market, including trusts, wealth management products and commercial paper.

WHAT DID EVERGRANDE DONE TO RAISE?

Evergrande stepped up efforts to reduce debt last year after regulators introduced caps on three debt ratios dubbed the “three red lines” policy. He said he aimed to meet all requirements by the end of next year.

Evergrande has given buyers significant discounts for its residential developments and has sold the bulk of its commercial properties to increase its cash flow. Since the second half of 2020, it has completed a secondary stock sale of $ 555 million, raising $ 1.8 billion by listing its property management unit in Hong Kong, while its EV unit has sold a stake of $ 3.4 billion to new investors.

It unveiled earlier this year its plan to split up three unlisted units – the online real estate and auto market Fangchebao, as well as theme parks and spring water businesses – in order to free up more capital. Fangchebao has already raised $ 2.1 billion in a pre-IPO in March.

IS EVERGRANDE A RISK?

China’s central bank noted in its 2018 financial stability report that companies, including Evergrande, could pose systemic risks to the country’s financial system.

Evergrande’s liabilities relate to more than 128 banks and more than 121 non-bank institutions, according to the letter. JPMorgan estimated last week that China Minsheng Bank has the most exposure in Evergrande.

Late payments could trigger cross defaults, as many financial institutions are exposed to Evergrande through direct loans and indirect holdings through different financial instruments.

In the dollar bond market, Evergrande accounts for 4% of high Chinese real estate yields, according to DBS. Any default will also trigger massive sales in the high yield credit market. A collapse of Evergrande will have a significant impact on the labor market. It employs 200,000 people and hires 3.8 million people each year for project development.

$ 1 = 6.4658 Chinese yuan Editing by Sumeet Chatterjee and Jacqueline Wong


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