China Evergrande Group (HK:3333 and EGRNY) has dodged death by default for a second time this week, cobbling together the cash to make a US$47.5 million coupon payment to bondholders before a grace period expired on Friday.
Missing the 30-day grace period would have caused default across other Evergrande instruments. It has US$19 billion in offshore bonds in all.
Evergrande went through the exact same process last Friday, when it managed to make a US$83.5 million interest payment on offshore bonds just before the grace period ended. But this second installment has done little to elevate investor spirits, with the company still staggering under its US$305 billion debt load.
The company's shares fell 3.3% in Hong Kong trading on Friday, quickly giving up gains at the open. That is steeper than the 0.7% decline in the Hong Kong benchmark, the Hang Seng Index, and significantly worse than the Hang Seng Properties index, down a similar 0.8%.
Evergrande's March 2022 U.S.-dollar bond rose ever so slightly but is still trading at 26 cents on the dollar. Its June 2025 offshore bond is asking 25 cents on the dollar.
It's not clear where the money is coming from. Communist leaders have told Evergrande founder Hui Ka-yan, once the richest person in Asia, to pay the company's debts out of his own pocket if need be, Bloomberg reports. He already has used his own money to get a project completed by another developer that had issued a bond guaranteed by Evergrande.
As I explained on Wednesday, Hui was the biggest loser on the new Hurun China Rich List for 2021. His fortunes fell US$25 billion, to US$11.3 billion, sending him south from fifth place to 70th in the ranking. That drop is mainly as a result of Evergrande's nearly 84% decline in share price this year.
Chinese regulators have told developers to prepare to repay both the principal and interest on their foreign bonds. China's National Development and Reform Commission and the State Administration for Foreign Exchange jointly called developers to a meeting, telling them to optimize their debt structures, report details of their repayment plans, and "jointly maintain their own reputations and the overall order of the market," Reuters reports.
The meeting, held on Tuesday in Beijing, wasn't publically announced, but it's significant. There were eight developers there in all, according to the business publication Caixin, including Sino-Ocean Group (HK:3377 and SIOLY), Kaisa Group (HK:1638), Shimao (HK:0813 and SHMAY), China Vanke (SZ:000002 and (CHVKY) ), Central China Real Estate (HK:0832) and Oceanwide Holdings (SZ:000046).
It isn't known what the other two companies were. Only Kaisa commented to confirm its presence at the meeting. Kaisa was the first Chinese developer to default on a U.S.-dollar bond, way back in 2015, but its business has since recovered.
Fundraising can still be strong if you have a strong brand. Sino-Ocean, which has its roots in the state-owned shipping giant Cosco, says it has landed sovereign wealth fund and institutional backing for a US$1.4 billion core office fund that it is raising to invest in the business districts of China's Tier 1 biggest cities.
Evergrande was China's largest developer in terms of sales in 2020, followed by Country Garden Holdings (HK:2007 and CTRYY) and China Vanke. Vanke and other well-capitalized developers such as China Resources Land (HK:1109 and CRBJY) are expected to benefit as smaller developers sell off projects at cheap prices. Both Evergrande and Country Garden have relied on a mass-market model of rapid turnaround on cheaper projects.
Citing two unidentified sources, Reuters reported that some developers at the Beijing meeting said they are aiming to hold talks with creditors to extend the maturity dates of their bonds or undertake debt restructuring. Regulators responded that developers should evaluate their repayment risk and disclose repayment difficulties, according to Reuters.
What's interesting is that regulators are pressing developers to sustain payments to offshore investors. The regulators, who are in charge of China's macroeconomic policy and its foreign-exchange markets, clearly want to contain any systemic risk that may spring out of the problems that individual developers are experiencing in deleveraging.
It shows the Chinese powers-that-be are concerned about China's creditworthiness on the international stage. We already have seen smaller developers Fantasia Holdings Group (HK:1777), Sinic Holdings (HK:2103) and Modern Land (HK:1107) default on U.S.-dollar bonds this month.
When Evergrande's main onshore operating company, Hengda Real Estate, said in September that it had "resolved" the US$35.6 million coupon payment due for an onshore bond, it looked like the company might prioritize payments to onshore borrowers inside mainland China, perhaps even at the direction of regulators. That seems now not to be the case, and Hengda simply tackled that bond's payment because it came due first.
Still, ratings agency Standard & Poor's said in September that an Evergrande default is ultimately highly likely, even if the company does negotiate with its borrowers.
"We believe nonpayment risk is extremely high and could ultimately lead to debt restructuring - meaning a default scenario is a virtual certainty," S&P says.
The meeting to tell developers to essentially behave themselves in their treating of foreign bondholders is a marked change in the attitude toward U.S. shareholders. With market-moving changes affecting the equity market, the Chinese Communist Party has shown scant regard for the impact such changes would have on the shares of U.S.-listed Chinese companies. For example, ride-hailing market leader DiDi Global (DIDI) has yet to recover from the ban on drafting new customers, slapped on it shortly after its initial public offering in late June. Its shares remain down 41% from the offering price of US$14.
Even-worse performance afflicted the for-profit education sector. After for-profit after-school tutoring centers were essentially banned, shares in tutoring center provider TAL Education Group (TAL) collapsed 94%.
Christopher Wood, the global head of equity strategy at Jefferies, says he would avoid the bonds of Chinese developers that are struggling to get under Beijing's "three red lines" of liquidity. Beijing clearly still intends to insist companies meet those mandates. But Wood says he believes Beijing can manage the fallout from this problem because it essentially caused the problem in the first place, and prepared.
He advises Asian and emerging-market investors to add to Chinese residential property stock exposure on any near-term bearishness surrounding debt issues and the introduction of a Chinese property tax. Don't assume Beijing will lift the loan-to-value down payment ratio on property, but it could, which would be very bullish for property stocks.
An ongoing effort to rein in property price gains is not necessarily negative for Chinese property stocks, Wood said. Wealthy Chinese people may switch their money from property into the stock market, which is gradually institutionalizing. Chinese President Xi Jinping has frequently repeated since raising the topic in 2017 that "houses are for living in, not for speculation," a sea change for a country where anyone with any money in the past invested it in real estate.
Wood, whose GREED & fear report I highly enjoy reading, says it is clearer that the intensity of the policy-driven deleveraging in the property sector is peaking, as evidenced by the decision of the People's Bank of China to ease mortgage lending for banks.
Beijing precipitated the current crisis. In August 2020, Chinese regulators introduced a policy of the "three red lines," limiting how much developers are allowed to borrow. Developers have to maintain a liability to asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash to short-term debt ratio of more than 1x.
Only 6% of Chinese developers could satisfy all three red lines, S&P said at the time of their introduction. Their efforts to meet more-stringent borrowing requirements has forced them to stall their business models of building and selling projects as fast as they can to generate the cash churn necessary to get the next project off the ground.
Home prices in China fell in more than half of China's 70 largest cities in September, the first month-on-month contraction since April 2015. Economists parse the numbers from the National Bureau of Statistics in different ways, but a seasonal adjustment made by Goldman Sachs tallied a 0.5% price decline compared with a year ago.
Evergrande shareholders are still likely to get cleaned out if the company collapses, so you're a brave or foolish investor to play that stock. Today's events show the company is doing its level best to sustain the interests of foreign and onshore bondholders alike. Future negotiations may still lead to a haircut for those bondholders, but they should still have a full head of hair and be far from bald when it ends.