Staying clear of Evergrande as crises deepens
- Last week Evergrande reiterated its warning that it may default on its borrowings
- Investors are nervous about the possible spillover into the broader real estate and banking sectors
- UOBAM has no Evergrande exposure, and remains underweight Chinese equities and bonds
From bad to worse
China developer Evergrande is finding it hard to contain its woes. While its US$300 billion worth of liabilities has been known for a while, things have recently gone from bad to much worse.
Last week the domestic ratings agency China Chengxin International (CCXI) downgraded the company’s bonds rating to A from AA, with the potential for further downgrades. The following day, a unit of the company, Hengda Real Estate Group, applied to suspend trading of its onshore bonds.
Default on the cards
The avenues for the company to address its cash crunch are also looking less hopeful. Evergrande informed investors last week that its property sales would likely continue to drop “significantly” in September. Meanwhile, it has yet to find buyers for the assets, including in new energy and property services, that it is hoping to liquidate.
As a result, the company has warned that it could default on its debt, echoing a similar warning made several weeks ago. Not surprisingly, Evergrande’s stock price has plummeted 80% since the start of the year, a trend that has been accelerating since June. However, over the longer term, a possible restructuring plan could be put in place to complete existing projects, and protect retail investors and Evergrande employees from the worst effects of a default.
Ripple Effects
However, it is not just Evergrande’s troubles that is causing concern, it is the possibility of contagion. Evergrande is a giant in China. Even today, after a number of selloffs, the company still has a hand in more than 778 real estate projects in over 233 Chinese cities.
While speculation mounts about the fate of other China real estate developers, related sectors may also not escape unscathed. The company is thought to continue to owe money to 128 banks and 121 non-banking institutions. As the market digests the growing possibility of Evergrande’s default, there are naturally fears of a broader China hard landing, propelled by a widespread wobble across building suppliers, construction companies, bank lenders, and the broader bond market.
Already, banks that have loaned money to Evergrande have been informed by China’s Ministry of Housing and Urban-Rural Development that the debt obligations due on 20 September 2021 will not be met. The country’s wider high yield bond markets have also been taking a hit, with indices at levels not seen for over a year.
UOBAM stays away from the fray
UOBAM investment funds do not have any exposure to Evergrande equities or bonds.
Within its fixed income portfolios, UOBAM takes a cautious approach to debt issuers not incorporated in Singapore. The Fixed Income investment strategy is to refrain from high yield credits offered by such issuers.
Even within the high grade bond sector, the team has been gradually reducing its overall China bond exposure throughout this year given increased market volatility. A number of significant developments including US sanctions against China military-related issuers, and China’s regulatory focus on establishing "common prosperity" has heightened uncertainties across certain companies and sectors.
The UOBAM exposure to fixed income issued by Chinese corporates, and the Chinese Property sector in particular, has declined accordingly. Going forward, UOBAM will continue to seek sound investment opportunities in China as and when value emerges.
Selected impact on banks
Lending to the property developer sector currently constitutes about 7% of total bank loans, of which about 0.1% can be attributed to Evergrande. This means that bank exposure to Evergrande remains fairly contained.
Even taking a broader perspective, and assuming that more highly leveraged property developers go the Evergrande way, the impact is unlikely to be uniform. Lending to property developers ranges from 4% - 7% for some of the larger banks but over 10% for some of the smaller ones.
The UOBAM Asia Equities team maintain their underweight call on China equities and within this, are underweight Chinese real estate and banks.
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