China Evergrande: real straits

China Evergrande investors are a steadfast bunch. No amount of warnings on the precarious financial position of the world’s most indebted developer has prevented them from buying its shares and bonds. But the latest test of loyalty should convince them that enough is enough.

Trading in the Chinese developer’s onshore bonds was halted on Friday morning following reports that it had requested government support to prevent a potential default.

Evergrande denied the reports but bond prices still fell from Rmb90 ($13) to Rmb67. Offshore debt yields rose to 15.7 per cent. Shares fell 10 per cent. S&P downgraded the credit outlook to negative.

Markets cannot be blamed for expecting the worst. Evergrande has more than $120bn of debt. Total debt to equity stands at 265 per cent, according to S&P Global, more than double that of local peers like Vanke. Signs of strain were already showing. This month it offered some of its properties at heavily discounted prices, down 30 per cent.

Its problems have not encouraged frugality. Evergrande has pushed ahead with an aggressive expansion into non-core businesses, from electric cars to beverages, and a shopping spree for new properties.

The looming cliff edge comes in January with a deadline, already once extended, to pay back Rmb130bn. Should it sell all its commercial properties, at current prices that would cover just over half that amount.

It has few remaining options to cover the remaining amount. One is to list its subsidiary Hengda Real Estate or its property management unit. Whether there would be sufficient demand is questionable. Even this funding would only succeed in helping Evergrande to cover just a couple of its upcoming debt repayments.

The sheer size of the debt pile means default would have a devastating effect on China’s property and banking system. Beijing has little choice but to offer some form of support. But it will not provide a blank cheque. Evergrande shareholders will have to bear the brunt. They should move out as soon as they can.

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