Real Estate

Country Garden is not a repeat of Evergrande, but it’s in the same hole

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Here we go again. As our MainFT colleagues report:

Shares in Country Garden slumped to a record low on Monday after the Chinese developer suspended trading in at least 10 of its mainland bonds, spurring a wider sell-off in property-linked stocks.

The company, formerly the largest developer in China by sales, missed international bond payments last week in a sign that a two-year liquidity crisis across the real estate sector was threatening to escalate.

Shares in the group fell as much as 18.4 per cent in Hong Kong following a statement released over the weekend that said several bonds issued by the company and its subsidiaries would be suspended from trading this week.

Country Garden has become a focal point of China’s latest deflation-related wobble. The housebuilder this month missed a $22.5mn coupon payment on two of its offshore bonds and has a 30-day grace period expiring on September 6 to make good.

Even if Country Garden makes the late payment, it would only be delaying what appears to be inevitable. The company’s sales to July were down 34 per cent year on year — before the wave of bad publicity that’s likely to make homebuyers even more wary about private developers finishing projects — and it has Rmb14.4bn ($2bn) of debt maturing within the next six months, as well as a $1.9bn offshore bond.

Here, via Morgan Stanley, is the maturity wall:

Recent sales rates suggest Country Garden has been recording a net operating cash outflow since June, and looks to be burning at least Rmb3-4bn each month, says Morgan Stanley. Avoiding default “is dependent on additional financing support from regulators in the coming weeks, but we see the chances of such help materialising becoming smaller,” it said.

Trouble has been brewing for weeks at Country Garden, which has been hit harder than most by the Chinese property crash because only 11 per cent of its sites are in top-tier cities, whereas 65 per cent of its sites are third-tier. Default would likely mean that local governments lock its presale deposits in escrow accounts to ensure project completion. Suppliers may also want early settlement of outstanding payables if it defaults. In other words, the cash crunch has the potential to become very bad indeed.

This month the company pulled a share sale at the last moment. Yang Huiyan, Country Garden’s chair and formerly the richest woman in China, last month transferred most of her stake to a charity founded by her sister having slotted shares repeatedly late last year.

“There is now growing market speculation that local government is conducting due diligence at the company,” says JPMorgan, whose equity capital markets team had handled the scrapped share sale. If Country Garden can’t deliver interim results, which will need its auditor’s sign-off, the stock would be suspended.

Chinese privately owned enterprises (POEs) never used to default that much, and those that did tended to avoid bankruptcy either by browbeating bondholders or by quietly becoming state-owned enterprises (SOEs). A liquidity squeeze in 2021 changed the picture:

China last year tried to reestablish principles of forbearance with a 16-point plan that included orders to lenders that they should treat POEs and SOEs equally, support bond issuance by quality developers, and be flexible about restructurings. Country Garden was at the time on the state’s list of high-quality developers.

Even so, effects of a Country Garden default won’t be as severe as last year’s Evergrande default, because the sector shake-out has already happened, with 40 per cent (by 2021 sales) of the market already in default, JPMorgan tells clients:

The contagion impact will likely be on non-distressed POEs (16% market share), assuming SOEs are safe. [We] believe the impact will mainly come from three fronts: (1) further abating the already-low confidence on POEs (i.e. sales will be impacted); (2) banks may be even more reluctant to provide new financing to POEs (despite government’s encouragement for more refinancing towards the property sector); (3) the potential default of Country Garden could encourage even more POEs to give up on honouring bond repayments which would show that, despite the 16-point measures by PBoC which aim to boost liquidity for POEs, there is no guarantee of survival.

In fact, the momentum of onshore bond issuance with government guarantee has also slowed down since 1Q23. This raises the question of whether government support will ever be sufficient to prevent another large-scale default.

© JPMorgan

Further, a potential Country Garden default could also have credit implications for other issuers in the sector. This could play out in 2 scenarios — 1) The downside scenario is where Country Garden fails to cure the missed coupons within the 30-day grace period. This along with effect of cross-default provision could result in repayment acceleration on US$10.8 billion of outstanding bonds denominated in US and HK dollars. 2) Under the worst-case scenario, the company’s onshore liquidity continues to deteriorate and eventually fails to stay current on its onshore debt obligation as well. The latter scenario of an outright default across the capital structure would be quite detrimental to operations, dampening hopes of stabilisation for the sector.

Voluntarily defaulting on offshore debt won’t necessarily trigger the cross-default provision on onshore debt so might be seen as an act of self-preservation, says JPMorgan analyst Frank Pan. The trade-off here is between keeping domestic operations funded and trashing international investor confidence.

Of Country Garden’s peers, Agile and SCE look the most at risk from weaker sales. Seazen and Longfor will likely attract some attention for the same reason but they both have investment property portfolios and better quality landbanks so there would need to be a more severe deterioration in sales to cause trouble for them, JPMorgan says. Here’s its ready reckoner of the top 30 developers:

For the Chinese banks, developer-loan exposure isn’t hugely significant at about 4 per cent of total banking assets:

Investor fears are focused on contagion across the 25 per cent (or thereabouts) of their total assets that are in residential mortgages, construction loans and property-backed debt. The unknown is whether China will be spooked into put new stimulus measures in place that support confidence among homebuyers in response to Country Garden’s particular set of problems. So far, seems not.

And in the continued absence of a bailout, Country Garden’s best option now is to pay the missed coupons, avoid outright default and knock heads among all its debt holders, because no one is coming to save them, says JPMorgan:

If there is any lesson to be learned from other defaulted developers, outright defaults normally mark the start of a downward spiral. Lengthy debt restructuring also makes it even more difficult for such issuers to rebuild their brand. Even if Country Garden manages to make the payment in time, there is no assurance that the company can muddle through the heavy maturity wall without some sources of incremental financing. As such, we believe Country Garden could be announcing distressed exchanges to term out its debt repayment if there is no company specific solution being offered by regulators.

Further reading:
Evergrande: crash-test dummy points to bond pile-up ahead (FT)


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