William John Market Report 24-09-21
Evergrande, one of the largest property developers in China, reaches its credit limit - William John assesses.
William John, Evergrande, China, Real Estate, Property, High Yield, Credit, Bonds

William John Market Report 24-09-21

William John Market Report 24-09-21

Category: Reports

The impending collapse of The Evergrande Group is to China what Lehman Brothers was to the United States. 

The world’s most indebted property developer may have reached its limits. On 23/09, Evergrande is expected to make a crucial bond payment using “off-exchange negotiations” according to the Financial Times. In addition to owing total liabilities reaching $300bn USD to banks, bondholders and suppliers, the company has issued $6bn in high yield wealth management products to thousands of retail investors (including its own employees). Given the scale of its credit issuances, the risk of defaulting on one of its debt covenants was enough to send the Asian markets into turmoil. 

Looking at the Bank of America high-yield Asia dollar bond index:

Source: William John Analytics, ICE Data Services

Although yields on high-yield Asia dollar dominated bonds have been surging since approximately mid-May, they have risen dramatically since September 21 from around 10% to 12%, exhibiting an investor sell-off in high yield debt. 

There are two conclusions to draw from this. First, market confidence in Evergrande coming through this crisis positively is slim to none. Second, and most importantly, the sell-off in high yield debt – a method of financing by most large Asian and Chinese Real Estate developers to start and finish their Real Estate projects – has a contagious market effect. 

According to the Financial Times, over 45% of the ICE Bank of America high-yield dollar bond index is made up of Real Estate companies. Hence, there are hundreds of Evergrande’s out there on varying scale, prompting the question – if Evergrande falls, how many others? 

It is currently uncertain to what extent Evergrande will collapse, whether it needs a restructuring of its covenants and debentures or whether it needs a state-backed loan or a bailout from the Bank of China. One thing is clear, the Communist Party must plan its response accordingly. The rise of the Chinese economy (the second largest in the world) has been fuelled by rapid and scalable Real Estate development, which in itself has been a contributor to the indebtedness of these companies. 

The most likely option now is that a creditor committee is appointed and Evergrande substantially sells off its non-core assets to make payments and restructure the debentures of its remaining credit. However, the high yield Asian bond market, of which many prominent Western investment houses have exposure due to its high-yielding, growth economy nature, is likely to lose out to an unlikely lapse in concentration from Chinese regulators letting one of the pillars of the Chinese economies develop in to such an uncreditworthy mess. 

The knock-on effects from the Evergrande debacle after its restructuring is likely to result in an overhauling of regulation and intervention by China on other developers in a similar position to Evergrande that may not have the “too big to fail” tag that Evergrande currently wears with honour. 

The future of Asian high yield credit and Chinese Real Estate looks glum – it is up to Xi Jinping to respond to save Eastern citizens and Western investors alike. 

Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.