Why Australia should be worried about China Evergrande’s fate Australian iron ore producers would do well to keep a close eye on the woes of the Chinese property development giant, whose bonds dropped to record lows last week. Karen Maley Columnist Aug 9, 2021 https://www.afr.com/markets/commodi...about-china-evergrande-s-fate-20210808-p58gt5 It’s the nail-biter that has investors watching on with a mixture of fascination and trepidation: will Beijing come to the rescue of giant debt-laden Chinese property developer, China Evergrande? It’s a question that has serious implications for Australian investors after the near-30 per cent slump in the price of iron ore since the May peak. There are fears that a collapse of Evergrande - which would send tremors through the Chinese real estate market, making it more difficult and expensive for Chinese property developers to raise debt - would further reduce demand for iron ore, given that China’s construction industry accounts for more than half of the steel used in the country. The financial stability of property giant China Evergrande is increasingly in doubt, and this has enormous consequences - not only for the Chinese economy, but also for suppliers, such as Australian iron ore miners. Bloomberg And that, in turn, could spark a further steep fall in the price of Australia’s largest source of export revenue. So far, commodity markets have been unruffled by the escalating anxiety over Evergrande’s future. The general consensus is that the importance of housing to China’s economy means that Beijing simply won’t permit a property developer the size of Evergrande to suffer the same fate as other heavily leveraged Chinese conglomerates that have collapsed in recent years, such as the insurer Anbang and airline and logistics company HNA Group. If Evergrande were to run into financial difficulties, the pain would ripple through the entire economy, hurting contractors and suppliers, as well as those home buyers who have paid large deposits for unfinished apartments. So far, however, Beijing has maintained a resolute silence on whether it intends to support the embattled group, causing investors to fret about the property titan’s ability to repay its $US300 billion ($408 billion) debt burden. Evergrande’s Hong Kong-listed shares have slumped 63 per cent this year, while the price of bonds issued by the company slumped to record lows last week after reports that creditor lawsuits against the company will be centrally handled in a Guangzhou court. Investors were unnerved by the development because a similar move to centralise judicial cases preceded a number of other major Chinese defaults, including at HNA Group and China Fortune Land Development. Investor jitters increased even further on Thursday after the release of a report by S&P Global Ratings which cut Evergrande’s credit rating - the second downgrade in as many weeks - because of the growing risk of non-payment of debt. “Evergrande’s liquidity position is eroding more quickly and by more than we previously expected,” S&P analysts said. “The company’s non-payment risk is escalating, not only for the substantial public bond maturities in 2022, but also for its bank and trust loans and other debt liabilities over the next 12 months.” The S&P report said disputes over contract payments at Evergrande were rising as contractors claimed the company had delayed payments. These contractors were applying for asset freezes as they aimed to resolve disputes in court, which could make banks even more reluctant to lend to the property giant. “The steadily increasing number of asset freezes signals strained liquidity”, S&P said. “As news reports continue to be negative, the company could experience a considerable downward spiral, with lenders potentially further tightening their risk exposure to the company.” The liquidity squeeze is occurring at a time when Evergrande faces hefty repayments. S&P estimates that the company has to settle more than 240 billion yuan ($50 billion) of bills and trade payables over the next 12 months, of which about 100 billion yuan is due this year. So far, Evergrande has been trying to ease its cash crunch and whittle down its debt by selling off assets. “In our view, substantial asset disposals now hold the key to the company’s repayment ability,” the analysts wrote. But some investors are concerned that Evergrande is running out of time to sell enough assets to meet its mountain of maturing debt. So far this year, Evergrande has raised more than $US8 billion from asset sales. And last week, it raised a further $US420 million by selling part of its stake in a Netflix-style streaming service. But there is a risk that investor confidence in Evergrande could be undermined even further if it starts selling assets for less than book value. For instance, Evergrande owns a 65 per cent stake in an electric vehicle manufacturer, which has yet to sell a single car. The market value of the operation has plunged by more than 75 per cent this year. There’s also a question mark over the valuation of Evergrande’s highly ambitious Ocean Flower Island, a 100 billion yuan man-made archipelago that is set to fully open next year, with hotels, theme parks and an opera house. Some investors are beginning to question whether Beijing will have the appetite to save Evergrande. They point out that the complexity of Evergrande’s corporate structure makes it hard to mount a rescue. What’s more, Evergrande is simply too big for another Chinese corporate, or a state-owned enterprise, to acquire. There’s also a philosophical question at stake, because Beijing doesn’t want to be seen to be bailing out companies that are too big to fail. Particularly when it involves writing cheques for hundreds of billions of dollars. Rescuing Evergrande runs counter to the resolve of Chinese regulators to reduce moral hazard by allowing the market to play a greater role in disciplining risky behaviour. The government has allowed some small property groups to default recently, including including China Fortune Land, a developer of industrial parks, and Sichuan Languang Development Co. Beijing also faces a formidable task in reaching a deal with bond holders that would see them agree to take a haircut on their investments. Evergrande is the second-largest issuer of US dollar junk bonds in Asia, after Japan’s SoftBank, with some $US19.5 billion of bonds maturing between 2022 and 2025. Because the bonds are held by a diverse group of investors, the Chinese government can’t mandate a solution. Instead, the situation has to be sorted through the market. In the meantime, the latest steep slide in Evergrande’s bonds indicates that the market believes there is a serious risk that it could default on its debts. It’s a vicious circle, because the greater the fall in the property giant’s bonds, the more it is closed out of capital markets, and the greater its dependence on obtaining loans from the country’s shadow banks.