Beijing’s priorities will determine who loses the most in Evergrande’s crisis

“We must not forget that housing is for living in, not for speculation,” Xi said during China’s 19th National Party Congress in November 2017. Xi’s proclamation was a signal to China’s highly-indebted property sector that a regulatory squeeze was on its way.

Since 2019, Chinese authorities have enforced a raft of regulations intended to curb the industry’s excessive debt and stave off a housing bubble. What Beijing calls the “three red lines,” or measures that property developers must meet in order to borrow more, have choked off such firms’ access to financing.

The tightened government controls hit Evergrande, the world’s most indebted property developer, hard, exacerbating the firm’s current $300 billion debt crisis. Some of the debt is coming due this week, and investors fear a default will destabilize the Chinese financial system and roil international markets.

“There is no guarantee that [we] will be able to meet [our] financial obligations,” Evergrande said in a Hong Kong Stock Exchange filing last week.

This Thursday, Evergrande’s must pay $120 million in loan interest on two bond loans—a critical test for the company’s liquidity and one that may reveal which parties stand to lose the most in an Evergrande collapse. The enormous size of the Evergrande crisis—its liabilities amount to 2% of China’s GDP—means its many stakeholders run the gamut, from institutions like bank creditors and bondholders to ordinary Chinese citizens who paid upfront for an unbuilt home and or bought Evergrande wealth management products; contractors and suppliers still owed money for their work; and Evergrande employees who loaned their savings to help the company.

Still, most analysts agree foreign bondholders have the highest probability of losses because they are lowest on Beijing’s list of concerns. The second worst-off may be China’s domestic banks since Beijing may strong-arm the nation’s lenders into doing business with Evergrande if it means minimizing harm to ordinary investors and stemming any broader market risks.

The losers

Last year, Evergrande was already mired in deep debt, but the property giant averted a potential default when a group of wealthy investors agreed to relinquish their right to force Evergrande’s $13 billion debt repayment.

But this summer, Evergrande’s luck ran out. Investor confidence in the company plummeted after several creditors took legal action to freeze Evergrande’s assets. Then, regulators summoned and publicly rebuked Evergrande executives for their risky financial practices, writes Rosealea Yao, senior analyst and property specialist at Gavekal Dragonomics, in an August note.

Ratings downgrades from Moody’s and Fitch earlier this month, coupled with August reports that Evergrande was trying to sell its flagship Hong Kong office for $2 billion, fueled concerns among stakeholders that the company was growing more desperate.

Shares of Hong Kong-listed Evergrande have now plunged 86% since last September to their lowest point in a decade, with a particularly steep drop beginning in July. Evergrande’s liquidity crisis has rocked Wall Street and global equities. Investors are worried about potential ripple effects from an Evergrande default. Hong Kong’s Hang Seng Index has dipped 5% in the last month, while the Hang Seng Properties Index hit a 52-week low on Monday. The U.S. indexes fell roughly 2% on Monday.

Evergrande chairman and founder Hui Ka Yan has lost nearly $16 billion of his fortune year-to-date and is now worth $7.3 billion, according to the Bloomberg Billionaires Index. Hui holds the majority 70% stake in his company, Meanwhile Hui’s billionaire friend, Chinese Estates’ Lau Luen Hung and Lau’s wife Chan Hoi-wan, are Evergrande’s second-largest shareholders with an 8% stake, each; Chinese Estates controls a 6% stake. The couple has reduced their exposure to the embattled property developer, selling off at least $64 million in Evergrande shares over the past month, according to Hong Kong’s South China Morning Post.

Holders of Evergrande’s Hong Kong shares have already lost big, and how Evergrande’s future unfolds on Thursday may identify the other major losers.

Most analysts agree that Evergrande is unlikely to receive a state bailout since Beijing wants Evergrande to serve as an example for other domestic property developers of what not to do.

Rather, the government will likely compel Evergrande to restructure its debt to keep contagion risks from spreading to other property developers and the broader market. An Evergrande restructuring could delay debt payments and allow the property giant to refinance and sell its assets at a normal schedule and fair price, says Philip Tse, director and head of property at securities brokerage Bocom International. The company could also face a corporate overhaul, with state-owned entities taking control of the group.

China has shown that indebted companies can be reined in via a forced restructuring without a full-fledged bankruptcy, as in the cases of conglomerate Wanda Group and aviation and tourism firm HNA Group, says Alicia Herrero-Garcia, chief economist, Asia Pacific at investment bank Natixis. Last March, provincial officials took control of HNA Group and started the conglomerate’s restructuring process. This month, the company secured strategic investors, signaling progress for its creditors. Evergrande holds “total assets greater than total liabilities—meaning an orderly restructuring is possible, absent of malfeasance and fraud,” says Teresa Kong, head of fixed income and portfolio manager at investment fund Matthews Asia.  

Should Evergrande undergo debt restructuring, offshore dollar bondholders, many of whom are foreign institutional investors, could be hit with a principal loss of over 50% in an optimistic scenario, says Tse. In the case of an Evergrande default, the same foreign bondholders face an even more “severe haircut of 70-80% on principal or a delay of payment for a prolonged period, say five to ten years,” he says.

International investment funds—the U.K.’s Ashmore, the U.S.’s BlackRock, Switzerland’s UBS and Hong Kong’s HSBC—are the largest holders of Evergrande’s dollar bonds at a collective $1.3 billion, according to institutional data compiled by Bloomberg.

The government’s priorities determine its hierarchies on how liabilities will be dealt with, says Max Zenglein, chief economist at Merics, a China-based think tank. “Foreign bondholders can expect to be at the bottom of the list and brace themselves for payment defaults,” he said.

Chinese banks also stand to lose large, particularly Evergrande’s top creditors which include China Minsheng Bank, the Agricultural Bank of China, and China CITIC Bank.

To solve the Evergrande crisis, the Chinese government may want the big banks to come in as the “lender of last resort [to] amend and extend” their loans, with the lenders highly likely to take a discount on the final amount repaid by Evergrande, says Kong.

Agricultural Bank of China for instance, the country’s third-largest lender by assets, has already set aside expenses to factor in unpaid loans from Evergrande, while Minsheng Bank and CITIC Bank are preparing to roll over some near-term debt obligations, giving Evergrande some breathing room for repayment, according to a Reuters report.

Taming unrest

Beijing is willing to shortchange banks and bondholders if it means sparing the larger financial system.

Last Monday, hundreds of retail investors and suppliers stormed Evergrande’s Shenzhen headquarters, demanding repayment for loans and unpaid work. The property giant has borrowed from around 80,000 retail investors and has offered to pay them back in the form of discounted apartments and parking lots.

Such a high-profile display of public anger likely unsettled Chinese authorities. Beijing’s emphasis on social harmony and common prosperity will drive a state response to mitigate the Evergrande fallout for ordinary citizens, even if billionaires, big banks, and foreign investors take a hit. Those who purchased unfinished homes from Evergrande (up to 1.6 million units still need to be delivered) and investors who bought Evergrande’s wealth management products are the two groups of utmost importance to Beijing. The “government wants to protect them and keep them off the streets,” says Kong.

Most analysts say that Chinese regulators are pushing onshore lenders to continue working with Evergrande so the property giant can repay retail investors and its contractors and vendors can finish in-progress apartment complexes and deliver units to homeowners who’ve already paid for them. Another plausible route is for a state-owned developer to step in to complete the unfinished units, says Herrero-Garcia.

If Evergrande customers start to question whether the company can deliver on its promise of completed homes, it could trigger a crisis of confidence in China’s property sector and potentially spill over into the financial markets.

The Chinese government will take the necessary steps to avoid such a catastrophe, experts say. Fundamentally, the Evergrande crisis is a “domestic Chinese issue.” A worst-case scenario is an Evergrande collapse bringing down other developers, says Paul Lukaszewski, head of corporate debt, Asia Pacific at Aberdeen Standard Investments., But the government won’t allow that to happen, he says.

Evergrande’s problems are “highly unlikely to create a systemic risk and the likelihood of this evolving into a global finance problem is very low,” Kong says. “The company does have a large debt burden, but it is insignificant given the scale of China’s financial system.”