China Evergrande’s restructuring ‘quasi unavoidable’ amid distress as ‘free pass’ on debt binge ends

·4-min read

Investors focusing on Asian high yield and distressed bonds are circling China Evergrande Group as the developer seeks fresh capital to pull through its biggest survival test after accumulating more than US$300 billion of liabilities.

The firm, struggling to contain a market sell-off and regulatory warning, may have to restructure its debt to prevent a fire-sale of key assets, some analysts said. Distressed debt investors are weighing the odds of the Shenzhen-based developer beating the drop as multiple credit rating downgrades point to a higher probability of default.

The developer boosted its chances of survival after regulators in Beijing handed it some breathing space. The Financial Stability and Development Committee approved the company’s proposal to negotiate repayment deadlines with lenders and other creditors, Bloomberg reported last week.

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“We have traded the bonds very actively in the last few sessions, including with new investors,” said Michel Lowy, chief executive of SC Lowy Financial in Hong Kong, which focuses on junk bonds and distressed credit. “We believe Evergrande will survive, but that some form of debt restructuring is quasi unavoidable.”

Lowy, a former Cargill and Deutsche Bank trader, co-founded the privately-owned investment bank and asset management firm in 2009 after the Lehman Brothers crisis. The firm traded US$10.5 billion of high yield bonds globally in the first half this year and US$22.5 billion in 2020.

China Evergrande’s 8.75 per cent notes due in June 2025, its most-active dollar-denominated bonds, traded at about 31 cents on the dollar on Friday, according to Bloomberg data. Still, they have fallen from 84 cents at the end of May as its billionaire founder Hui Ka-yan signalled urgency by putting some of its key assets up for sale to raise cash.

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Its shortest-maturity bonds due in March 2022 fetched 35 cents on the dollar, versus 99.6 cents at the end of May, showing that markets have already priced in the risks of default and haircut, according to Jackson Chan, assistant manager of fixed income research in Hong Kong at iFast Financial.

“Although the probability of any debt restructuring involving maturity extension and haircut is increasing, we believe that the current price is already reflecting the maximum haircut level,” he said in a report. “The incentive to sell the bond now is quite low, and investors will miss the opportunity for a possible rebound.”

Evergrande’s debt reckoning was long in coming even as its borrowings ballooned and China started clipping the wings of Anbang Insurance, HNA Group, CEFC Group and the Tomorrow Group from 2016, groups known for their debt-funded rapacious growth. Other entities linked to shadow financing, such as China Huarong Asset Management, are now facing severe financial stress and struggling to avoid bankruptcy.

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“For the first several years of the crackdown, Evergrande seemed immune from pressures to deleverage, becoming one of China’s largest and riskiest corporate borrowers,” Nicholas Borst, director of China Research at Seafarer Capital Partners, wrote in a report last month. “Evergrande’s free pass, however, now appears to be over as regulators target it and other property developers with the ‘three red lines’ borrowing regulation.”

Chairman Hui Ka-yan and senior executives of Evergrande’s units pledged to deliver homes to buyers amid a liquidity crunch. Photo: Handout
Chairman Hui Ka-yan and senior executives of Evergrande’s units pledged to deliver homes to buyers amid a liquidity crunch. Photo: Handout

Late last month, Hui warned of default risks if its effort to raise cash falls short and may face legal actions. The firm has reportedly put up its headquarters in Hong Kong for sale, as well as its equity stakes in listed car-making and property management units.

China Evergrande had 1.97 trillion yuan (US$305 billion) of liabilities on June 30, a source of consternation for policymakers trying to contain any potential systemic risk to the financial system. The amount included 240 billion yuan of borrowings and 951 billion yuan of payables, both due by June next year.

Hui has at least about four months to figure out his next moves. Evergrande does not have any bonds coming due until January when investors can ask for repayment on 8.2 billion yuan of local bonds, according to iFast Financial. However, it still needs to service 3.8 billion yuan of bond interest until then.

“At this point, we still think Evergrande has the resilience to survive for a longer period,” Chan at iFast Financial said. “However, if it really gets into any legal process, it may take a long time to come up with a recovery plan for the relevant bonds.”

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