After weeks of radio silence since being suspended from trading on the Hong Kong Stock Exchange, Chinese property giant Evergrande is about to face its day of reckoning.
The 30-day grace period for an offshore bond payment that the company initially missed on September 23 is going to expire at the end of this week.
Once a darling of China’s booming property sector, Evergande is now at risk of the country’s largest-ever corporate default with more than $400 billion in debts, triggering financial woes in the world’s second-biggest economy.
So how is this likely to play out in the coming days? What happens next if a formal default occurs?
Will Evergrande formally default without a bailout?
Investors are watching closely whether Evergrande can make Saturday’s deadline of $110 million in interest payments.
A further $60 million interest payment was missed on September 29 and the grace period is also expiring on those debts.
Moody’s has given Evergrande’s debt a junk rating of Ca, the second-lowest category, reflecting “its high liquidity and default risks because of its sizable debt maturities over the next six to 12 months”.
“It also reflects the weak recovery prospects for Evergrande’s creditors if there is a default,” Moody’s said in a report.
Fighting for survival, Evergrande has been scrambling to raise funds by selling assets and offering discounts on apartment sales.
Earlier this month, its shares were halted on the Hong Kong Stock Exchange, sparking speculations of potential asset sales.
The Chinese media previously reported that Evergrande was in talks with another Hong Kong-listed Chinese developer Hopson about selling a majority stake of its property services unit to raise more than $7 billion much-needed cash.
However, that deal has fallen through, with Hopson and Evergrande both informing the Hong Kong Stock Exchange that they were unable to agree to terms.
Hong Kong media reported on Tuesday that “the transaction didn’t win blessings from the Guangdong provincial government.”
Both companies will resume trade on the share market today.
Jim Harrowell, the former president of the Australia China Business Council NSW branch and partner at law firm Hunt & Hunt, told the ABC that a formal default seems inevitable.
“In the current situation, it would be very difficult for Evergrande to raise funds from disposing of assets as potential purchasers are more likely to wait until the company collapses and deal with a liquidator.”
But Weiping He, a researcher in financial markets regulation and company law from Monash University, isn’t convinced that a formal default will happen.
“In my view, it is not likely,” Dr He told the ABC.
On Sunday, governor Yi Gang from People’s Bank of China (PBoC), China’s central bank, said in a virtual meeting of the G30 that Beijing can “contain” risks to China’s financial system and economy stemmed from Evergrande’s debt crisis despite admitting that it has caused “a little bit of concern” for Beijing, according to Bloomberg.
Last week, Zou Lan, the head of financial markets from PBoC, signalled that Beijing was eager to protect the interests of consumers who are exposed to Evergrande.
Dr He said the Chinese government is reluctant to bail out Evergrande at this stage.
“Their approach so far seems to be that financial institutions and local governments would assist to complete unfinished housing projects thus to minimise the impact on housing consumers,” she said.
“Based on the investigations into the books of Evergrande on the part of the government, the PBOC so far has held the view that the externalities could be managed.
“Things might get worse if there are more revelations, but it would take time.”
Dr Harrowell echoed Dr He’s view on the bailout but said: “Secured creditors are likely to run out of patience very soon and may move to exercise their rights under their security unless there is a credible plan.”
Why is a formal default a big deal?
Fears of a contagion effect have been intensifying in the past weeks as two smaller Chinese developers, Sinic and Fantasia, have defaulted.
Richard Holden, a professor in economics at UNSW, told the ABC that a formal default can cause various disruptions.
“A formal default kills confidence, leading to a potential downward spiral where new capital cannot be raised, more defaults occur, and so on,” he said.
Although the embattled company is headquartered in Shenzhen and listed in Hong Kong – two different jurisdictions – Dr Harrowell said the basic legal frameworks in both Shenzhen and Hong Kong dealing with loan defaults and corporate failures are very similar.
“Australia, China and Hong Kong have basically codified their laws relating to insolvent companies — corporations that cannot pay their debts,” said Dr Harrowell.
“The formal procedures may differ, but the essential framework is the same.
He said, if Evergrande collapses, its considerable stock of properties, including partly completed projects, would likely flood the market at less than cost, which will inevitably drive property prices down and make it hard for other developers to maintain their prices.
“Those who have bought properties off the plan from Evergrande are likely to lose the funds invested, so they won’t be able to buy elsewhere,” Dr Harrowell said.
“And those thinking about buying a property will be nervous about the potential of other developers failing, making it hard for them to find buyers for their properties.”
So far, Evergrande has more than 70,000 investors and stalled construction on homes for more than 1 million home buyers.
Can the Chinese government control the crisis?
Evergrande’s debt crisis has already had a knock-on effect both in China and beyond – causing disruptions on the Australian share market and for commodity prices.
On Monday, China’s National Bureau of Statistics revealed that the Chinese economy grew at its slowest pace in a year in the third quarter of 2021, at 4.9 per cent, with the real estate and construction industries shrinking 1.6 per cent and 1.8 per cent respectively.
The property market has been a key driver of economic growth in China since the mid-1990s and accounts for around a quarter of the Chinese economy by some metrics.
Economist James Laurenceson, the director of the Australia-China Relations Institute at UTS, told the ABC that Beijing will be focused on two objectives to contain the crisis.
“Shoring up social stability, such as by protecting the thousands of households that have put down cash for yet to be completed apartments,” he said.
“Second, limiting contagion so that an Evergrande default doesn’t spiral out of control to become a much bigger property bust and debt crisis.
However, Professor Laurenceson said if a formal default occurs for Evergrande, the direct impact on Australia would be relatively small.
“Australian investors have a very limited exposure,” he said.
“We’d only need to be concerned by a bigger contagion scenario that slowed China’s growth more generally, hitting demand for iron ore and causing Chinese households to tighten their purse strings.
“But Beijing will be keen to prevent that happening in the first place. We also shouldn’t forget there’s other mitigation mechanisms in place.
“For example, RBA research shows that Australia’s flexible exchange rate is an impressive shock-absorber when the local economy is hit by adverse developments overseas.”
