Real Estate

China Evergrande/credit risks: warning for investors numbed by false alarms


At a time of minuscule interest rates, towering yields above 15 per cent for US dollar-denominated Chinese junk bonds tempt investors. The largest issuer of these, China Evergrande Group, tops the rankings with yields at 25 per cent. Read these as signalling a looming crisis for the indebted real estate group.

Evergrande’s 8.75 per cent 2025 dollar bond fell to 62.6 cents on the dollar on Monday, according to Bloomberg data, after a court ordered the freezing of a bank deposit held by its majority owned Shenzhen-based subsidiary Hengda Real Estate. Hengda, which holds much of Evergrande’s property assets in mainland China, has missed several payments on its commercial bills. Hengda had $32bn outstanding short-term bills by end 2020. Evergrande’s Hong Kong listed shares fell 16 per cent.

Warning signals for Evergrande’s bonds and shares have occurred regularly. No wonder. It has $88bn in total debt, dwarfing its shareholder equity on a ratio of 224 per cent. Net of cash, its liabilities make up almost all of its $142bn of enterprise value, according to S&P Capital.

Not surprisingly, Evergrande can struggle to secure long-term financing. It relies heavily on trust financing, loans from non-bank financial institutions, for about 40 per cent of its total debt, says rating agency Fitch. These loans have long been targets of local regulatory crackdowns, and carry higher refinancing risks.

Meanwhile, China’s fixed income market looks shaky. Corporate bond defaults there have reached a record $18bn in the first half. Recent ones, including three state-owned companies, cast doubt on the implicit government backing for these securities. About 40 per cent of all credit defaults this year belong to state-owned companies — compared with less than a tenth just three years ago.

Investors remain fickle. The mere mention of a possible Evergrande dividend last week brought buyers back for its shares and bonds. Yet local bank balance sheets teem with bad loans. Without government backing, investors will suffer badly should Evergrande fail to secure more liquidity. Good reason to avoid Evergrande shares and bonds.

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