Investors brace for fallout as China’s Evergrande warns of ‘tremendous pressure’ on cashflow

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Investors around the world are increasingly bracing for the fallout from the restructuring or even a potential default at Chinese property giant Evergrande.


Overseas investors own US$7.4bn of China Evergrande Group’s US-denominated debt, with investors including Ashmore Group (LSE:ASHM) PLC, Allianz and BlackRock (NYSE:BLK).


Evergrande, which had debts of almost $90bn at the end of June from domestic and international banks and bond investors, issued a statement to the Hong Kong stock exchange where it warned of “tremendous pressure” on its cashflow and liquidity as it faces difficulties making sales to pay off its huge debt pile.


With hundreds of investors having showed up at its offices over the weekend to demand a meeting with company executives, according to local and international newswires, the company said management and financial advisers will explore “all feasible solutions” to alleviate its liquidity crisis.


Monthly sales in August were reported to have almost halved to RMB 38.1bn from RMB 71.6bn three months earlier, it said, blaming “the ongoing negative media reports” as having “dampened the confidence of potential property purchasers” in a typically strong month for real estate sales in China.


Evergrande said September is therefore likely to see “significant” further decline in sales, resulting in “the continuous deterioration of cash collection by the group which would in turn place tremendous pressure on the group’s cashflow and liquidity”.


The Shenzhen-based conglomerate said discussions on some major potential sales were ongoing but it had made “no material progress”.


With some subsidiaries failing to update on RMB934mln of liquidity issues, the company said all its combined challenges and uncertainties meant there was a strong chance it may default on its financing arrangements.


A day earlier, the company had insisted that rumours about its potential bankruptcy “are completely untrue”.


“The company has indeed encountered unprecedented difficulties at present, but it is determined to … do everything possible to restore operations as usual, and protect the legitimate rights and interests of customers,” it said in a statement on Monday.


Potential fallout


“If Evergrande collapses we think that policymakers will seek to protect homebuyers but allow other creditors to take losses,” said Julian Evans-Pritchard, senior China economist at Capital Economics.


It would be the biggest test that China’s financial system has faced in years, Capital Economics said in another note last week, with a resulting banking failure triggered by a collapse seen as the “single most likely scenario that could lead to a hard landing in China”.


Assuming that 45% of Evergrande’s debt is still backed by collateral, as at the end of 2020, that leaves roughly RMB320bn in debt that may not be recovered, Evans-Pritchard calculated.


The onshore portion of this debt is equivalent to one percent of commercial banks’ tier 1 capital ratio, he noted, so a complete write-off and with all the losses flowing to the banks, average tier 1 capital ratios would fall from 11.9% to 10.9%, which is still well above the regulatory minimum of 9.5%.


But these calculations exclude Evergrande’s bonds, which totalled RMB206bn (US$32bn) at the end of 2020, and are expected to have risen further since then.


The distribution of debts and banks ability to absorb them both likely to vary, Capital Economics is expecting some individual banks will “run into problems” due to their exposure to Evergrande.


But the People’s Bank of China should be able to step in to prevent a liquidity squeeze in the bank market.


The financial system as a whole appears to be in a strong enough position to absorb an Evergrande collapse, said Evans-Pritchard, assuming no other major property developers are also in trouble.


“This assumes that Evergrande is an isolated case and not the start of a wave of developer failures. That’s not a given with the headwinds facing the sector.”


Indeed, last week Citigroup noted that sales across the sector in August were down 19% on the year before, with worries about “contagion impact” from Evergrande leading to “some difficulty in bond issuance onshore (due to demand) and offshore (due to cost)”.


On Monday, Blackstone scrapped a US$3bn takeover deal of Chinese office property developer Soho China

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