HONG KONG – For weeks, global markets watched the struggles of China Evergrande, a tottering real estate giant weighing in at $ 300 billion or more in bonds that seemed barely able to make required payments to global investors.
On Thursday, three days after a deadline that left bondholders with nothing but company silence, a major credit rating agency said Evergrande was in default. But instead of resolving questions about the fate of the Chinese juggernaut, the announcement only deepened them.
The firm, Fitch Ratings, said in its statement that it had placed the Chinese property developer in its “restricted default” category. The designation means that Evergrande had officially defaulted but had not yet initiated any type of bankruptcy filing, liquidation, or any other process that would end its operations.
It is the nature of this next step – bankruptcy, a fire sale, or business as usual – that remains unknown. In the United States and many other places, bondholders could push a reluctant company into some form of reorganization, usually in court, and split the pieces.
It can still happen. But Evergrande is faltering in China, where the Communist Party keeps a firm grip on business collapses to keep them from expanding out of control. With Evergrande, the risk is high: a sudden dismantling of the business could affect the country’s financial system or, potentially, the many landlords in China who have already paid for Evergrande apartments that are yet to be built.
The company’s largely resigned investors are now waiting to see what Evergrande does, under the guidance of a group of state-linked financial guys, next.
“We all expected that Evergrande wouldn’t be able to pull a rabbit out of its hat,” said Michel Löwy, Managing Director of SC Lowy, an investment firm with a small position in Evergrande bonds.
“Now the ball is in their court to come up with some form of restructuring proposal,” he said.
Evergrande did not respond to a request for comment. Fitch said the company had not responded to its own request for confirmation as to whether it had reached or missed an $ 82 million payment to bondholders due on Monday, prompting the rating firm on Thursday Act.
Fitch also placed Kaisa, another large and struggling developer, in its “narrow default” category on Thursday after the company failed to pay bondholders $ 400 million earlier this week.
These flaws test a long-held understanding among foreign investors that Beijing will ultimately step in to save its biggest companies.
For years, many investors have given money to companies like Evergrande based on this assumption. But more recently, authorities have been more willing to let companies go bankrupt in order to bring China’s unsustainable debt problem under control.
To stress this point, China’s central bank blamed its problems on Evergrande’s “mismanagement and reckless expansion” and said the crisis was confined to Evergrande. Yi Gang, the central bank governor, said on Thursday that Evergrande would undergo something that looks like a typical reorganization, suggesting that a bailout was not an option.
“The risk of Evergrande is a market incident that will be properly handled in accordance with the principles of commercialization and the rule of law, and the rights and interests of creditors and investors will be protected in accordance with the law,” he said. .
Evergrande had previously said he would “actively engage” with his foreign creditors to work out a restructuring plan. But it is clear that Beijing will play a role. Earlier this week, Evergrande said officials from several state-backed institutions had joined a risk committee that would help the company restructure.
Beijing has been at the forefront in the aftermath of past corporate disasters. Three years ago, Beijing took control of Anbang Insurance Group after arresting its chairman, who was later sent to jail for fraud. Early last year, local government officials stepped in to take control of HNA, a transport and logistics conglomerate struggling with debts resulting from expensive overseas acquisitions. Under their leadership, the ailing company was pushed into administration.
Foreign investors challenge this trend at their peril. The Communist Party controls local courts and has a habit of leaving little or nothing to foreign investors.
Investors could look for assets overseas, but the process could be complicated.
“Evergrande is complex and has entities in companies both inside and outside the People’s Republic of China,” said Daniel Anderson, partner at Ropes & Gray law firm in Hong Kong.
“There is no clean and unique legal mechanism that can be implemented to restructure the group,” he said. “Consequently, it will have to be inter-jurisdictional, which will make it very complex. “
Understanding the new Chinese economy
An economic overhaul. China is adopting new measures to change how its business works and limit the power of rulers. Driven by a desire for state control and autonomy, these changes mark the end of a golden age for private companies that have made the country a manufacturing power and a hub of innovation.
For more than a decade, Evergrande has been China’s largest developer, making money out of a real estate boom on a scale the world has never seen. With each success, the company has expanded into new areas, such as bottled water, professional sports and electric vehicles.
But he borrowed too much to pay the bills he owed banks, entrepreneurs and investors. In addition to its accounting debt of $ 300 billion this year, some experts estimate that its liabilities could rise to an additional $ 156 billion.
Its financial problems are in part the result of Beijing’s attempt to calm the Chinese housing market. Fearing an overflow into the wider financial system, regulators cracked down on developers like Evergrande, forcing them to repay debt to banks and other financial institutions.
Evergrande has struggled to sell his sprawling empire. He failed to sell an electric vehicle business despite the discussions with interested buyers. Experts have warned that buyers are waiting for a clearance sale.
But the slowdown in the housing market and the drop in demand for new apartments made matters worse.
Evergrande has often relied on a pre-sale model of apartments before they were fully built. As many as 1.6 million buyers were still waiting to move into Evergrande apartments in September when the company gathered its senior executives and asked them to publicly sign what he called a “military order” – a pledge securing the completion of hundreds of development projects that had already been sold.
But to keep that commitment, Evergrande needed to either pre-sell new properties in order to raise enough money to keep operating, or find other sources of cash.
Remarkably, for a few months Evergrande managed to keep paying bondholders. But few thought Evergrande would last long. Other Chinese developers began to struggle as investors panicked and sent their cost of borrowing to new heights. With limited access to finance amid a broader industry crackdown on debt, more than 11 real estate companies have defaulted on their bonds this year.
As her problems worsened, Evergrande spoke less and less about her prospects. To find out if he had made his payments, the financial world turned to bondholders to ask if they had received any money. In China, censors suppressed any negative news.
Now, investors must wait for whatever information Evergrande and Beijing deem worthy of publishing.
“The idea,” said Mr. Löwy, of SC Lowy, “is that we have to understand what the assets really are, what the liabilities really are and in what form the business can survive.”