Evergrande Collapse May Hit Regional Financial Stability: RBA

The Reserve Bank of Australia warned on Friday about the risks of a collapse by China Evergrande, the world’s most indebted developer, to both the Chinese economy and countries like Australia that are heavily dependent on robust growth in China.

The RBA, in its latest Financial Stability Review, said: “Vulnerabilities in China’s financial system remain elevated and authorities face a difficult balancing act.

“If they act too quickly in addressing these vulnerabilities, confidence in the implicit guarantees that underpin much of China’s financial system could collapse, which would lead to financial distress,” the central bank said.

“In contrast, if they act too slowly, the probability of more severe financial stress in the future will increase. Continued bailouts also risk further entrenching perceptions of implicit guarantees.”

It noted that Evergrande has been fighting a losing battle, with its debts expanding rapidly in recent years but its “profitability has not kept pace with the increase in debt”.

“It is also facing a liquidity crisis because of its declining profitability, the shorter maturity of its liabilities relative to its assets, and an inability to raise additional debt to meet interest payments and pay suppliers and contractors.

“To increase its cash holdings, Evergrande has: sold properties at steep discounts; sold other assets; delayed payments to suppliers, holders of its wealth management products and on some of its other liabilities; and sought to offer debt holders discounts on properties in lieu of payments.”

Collapse ‘expected’

But these steps were “insufficient and Evergrande is widely expected to collapse without some type of government support.” If the company collapsed, it “could trigger wider stress in China’s financial and real estate sectors.”

Some observers have suggested that Evergrande is undergoing a “controlled demolition” as Beijing works to deleverage hundreds of billions of dollars in debt held by Evergrande Group and other developers.

Authorities have been prodding government-owned firms and state-backed property developers such as China Vanke to purchase some of Evergrande’s assets in a bid to plug Evergrande’s $305 billion in debts.

Local governments in China have also been ordered to limit the impact of the crisis on Chinese homebuyers, as well as suppliers and workers within the construction sector.

Media outlet Caixin revealed late last month that special custodian accounts had been set up for Evergrande property projects to protect funds earmarked for housing projects from being diverted.

Analysts say the plunge in land and home sales that has occurred in China in recent months will affect provincial governments in China, as land taxes make up a fair chunk of their finances.

But, while officials throughout China scramble to manage the situation at home, the big question for investors and businesspeople overseas is, how much impact is the slow downsizing of Evergrande likely to have on them and regional economies.

It is still too early to tell. Holders of bonds sold by Evergrande and other property companies look likely to face a significant ‘haircut’, but regional economies such as Australia or countries in Southeast Asia could also take a hit, if there is a major slowdown in demand and purchasing power in China.

‘Large Off-Balance Sheet debt’

One reason why the scale of the Evergrande crisis grew so large is because debts accumulated over many years were ‘disguised’ or concealed off Evergrande and other developers’ balance sheets.

Investment bank JPMorgan and Hong Kong property analysts say this tactic was used by Evergrande and many of its major rivals to make it look like they were conforming with new borrowing cap rules – the ‘three red lines’ introduced by financial regulators in August 2020.

“Instead of true deleveraging, we think Evergrande has shifted some of the interest-bearing debt to off-balance sheet debt,” JPMorgan’s analysts said. “Commercial papers, wealth management products and perpetual capital securities, etc, which are not officially counted as debt.”

They estimated Evergrande’s “net gearing,” as debt as a ratio of a firm’s equity is known, was at least 177% at the end of the first half of the year, instead of the 100% its accounts reported.

“It is possible that the real gearing could be even higher, as data on some off-balance sheet debt is not publicly available,” JPMorgan added, saying the “disguised” debt as it called it added up to 55% of Evergrande’s overall debt.

Other major firms whose gearing levels were likely to be higher than formally reported included R&F Properties at 139% versus the 123%, Sunac China Holdings at 138% versus 87% reported and Country Garden at 76% versus 50% reported.

Another Payment Missed

Meanwhile, Evergrande Group missed another dollar bond interest payment deadline this week in another indication of its dire financial state.

While the developer does not have any more onshore or offshore bonds maturing this year, it must still make coupon payments for its offshore bonds totalling $547.57 million by December 28. It is also due to make a 121.8 million yuan ($18.84 million) coupon payment on an onshore bond on October 19.

• By Jim Pollard with Reuters

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