The knock-on effect of the potential debt defaults of China’s two most indebted property companies—Country Garden and Evergrande—will not only be devastating for their various stakeholders, but it could also have a catastrophic effect on the fate of other debt-ridden Chinese companies and their future ability to raise capital from the international capital market, according to financial experts.
Their default could also have spillover effects on the global market investors, who could lose confidence in Chinese assets and seek safer havens.
Country Garden announced on Tuesday that it had defaulted on a HK$470 million (about $60 million) principal payment, setting the stage for one of the country’s largest debt restructurings. Simultaneously, a foreign bondholder group expressed concerns on Monday that Evergrande’s failure to obtain regulatory approval for its offshore debt restructuring, announced earlier, could lead to its liquidation at the next winding-up hearing on Oct. 30.
A debt crisis has plagued China since 2021, with hundreds and thousands of Chinese residences remaining unfinished because an estimated 40 percent of private property developers have defaulted on loans.
Ever since, housing and capital market confidence has also plummeted, restricting developers’ liquidity and forcing many to buy time in the form of short-term debt extensions and rework repayment schedules.
But for a household name that built over 3,000 housing projects in smaller cities last year and employed nearly 70,000 people—and was once the largest private-sector developer in the nation—any default by Country Garden would have a deeper impact on China’s housing market, fear experts.
“A potential default or restructuring would cause knock-on impacts to various stakeholders, including Country Garden’s customers, supply chain and creditors (including the US dollar bond market),” wrote David Gan, senior credit analyst at Nikko Asset Management, in a note exclusively for institutional investors but accessed by The Epoch Times.
According to Mr. Gan, the default or restructuring would have a more significant impact on Country Garden’s consumers and supply chain than on the credit market because the contract obligations (the amount paid by consumers for properties that have yet to be delivered) and supply chain-related trade and other payables are both greater than interest-bearing debt.
A debt default will further weaken faith in China’s overall property sector since homebuyers will be less likely to acquire properties from other developers, while suppliers and creditors may tighten their credit terms to developers.
Despite a recent flurry of support measures—including lowering minimum down payment requirements and minimum interest rates for second homes and cutting interest rates on existing mortgages on first homes—the slump in China’s property prices continues to deepen with increasing losses in new home prices, property investment, and sales.
Looming Catastrophe
Nevertheless, while Country Garden’s debt default will remain restricted to the Chinese property sector, according to an ad hoc group of offshore bondholders (based in New York, London, and Hong Kong) of the embattled Evergrande Group, the fallout of a default by Evergrande could be much more significant.Evergrande revealed in late September that its attempt to restructure its large debts had been put on hold due to a regulatory investigation into its primary subsidiary.
The company announced that it is “unable to meet the qualifications” for issuing new notes, which refer to short- or medium-term securities, because Hengda Real Estate Group is under investigation by the China Securities Regulatory Commission (CSRC) and the National Development and Reform Commission.
However, in a statement released on Monday, the bondholder group said that Evergrande’s failure to acquire Chinese regulatory permissions had resulted in “a spectacular turn of events,” rendering the “heavily negotiated offshore restructuring” in limbo.
The group added that the offshore restructuring aimed to ensure that Evergrande can continue as a going concern and considered using the company’s offshore assets as additional credit support in accordance with international restructuring principles.
The restructuring also included the provision of extra collateral in the form of the bondholder group’s non-core offshore assets, reflecting that the economic interests in these offshore assets now belong to creditors due to the group’s insolvency. Following the restructuring, Chairman Hui Ka Yan, currently under police surveillance for unspecified crimes, would no longer be the controlling stakeholder.
“[The] rejection came as a complete surprise to the Ad Hoc Group, which had been repeatedly assured by various stakeholders that the deal had been approved. It is inexplicable to the Ad Hoc Group why the [Evergrande] Group, with an army of experienced onshore and offshore advisors along with its high caliber board members, was not able to adequately prepare the application to obtain the required waiver from CSRC,” the statement reads.
The only way out for Evergrande is to obtain the required regulatory approvals, otherwise, the company could face liquidation at the next winding-up hearing on October 30, 2023, which “will likely lead to the uncontrolled collapse of the Group,” it said.
Risks Spreading
Given that the property sector makes up about 20 percent to 30 percent of the Chinese economy (including related sectors), the risks of these defaults are spreading to local government financing vehicles (LGFVs) and shadow banks, according to Ian Chong, senior portfolio manager at Nikko Asset Management.That’s because there’s a symbiotic link between Chinese property developers, local governments, and trust companies, which administer trust products for high-net-worth individuals and small businesses, said Mr. Chong.
Chinese trust companies lend money to property developers, who lease and buy land from local governments. The local government finances infrastructure and public projects through LGFVs or shadow banks using income from various sources, including land sales.
“When property developers in China start to default, this chain will begin to be impacted,” Mr. Chong wrote.
Nikko Asset Management analysts say China needs to move its economy away from real estate and toward high-end manufacturing and consumer spending.
Therefore, according to these experts, the bottom line is that despite recent coordinated measures, Beijing’s policy support is still insufficient. They said a “larger bazooka type of support” may be needed for the Chinese property sector to improve significantly.
