Not so grand

Its bonds are not a hot property...

He made his name in Guangdong province, but it’s Liaoning’s provincial capital Shenyang that’s shaking the foundations of Xu Jiayin’s sprawling and heavily indebted empire. The group has been under pressure since last September when Xu’s listed flagship China Evergrande was reported to have approached the Guangdong government’s for help in averting a cash crunch. But the latest round of rumours follows a report by WeNews, an online news service run by Caixin Weekly, that the banking regulator (CBIRC) is investigating unlawful connected transactions between Evergrande and its Shenyang-based banking affiliate Shengjing Bank (see WiC543).

The amount is said to top Rmb100 billion ($15.2 billion). Evergrande owns 36.4% of Shengjing Bank and current regulations cap single client exposure at 15% of net capital. Banks are also forbidden to extend non-guaranteed or unsecured loans to related parties.

Evergrande released a statement following its annual strategy meeting on June 3, saying that its relationship with Shengjing Bank complies with legal requirements. A number of analysts are also sceptical about the more alarmist media reports. JPMorgan, for example, published a fixed income report suggesting that the claims “sound somewhat improbable”. It noted that the Shenyang bank reported only Rmb27.7 billion in related party transactions including loans and financial assets.

What no one doubts is that Evergrande’s ambitions are putting pressure on its capacity to service its debts, especially after Xu announced a $41 billion push into electric cars in 2019. That business appears to have received strong backing from the Shenyang govenment, which signed a Rmb120 billion agreement last June with Evergrande to build an EV and battery factory in the northeastern city.

As always, Chinese regulatory risk is ever present but notoriously hard to quantify. But the latest news saw investors swiftly dump Evergrande’s bonds when rumours of the CBIRC probe surfaced. Evergrande bonds maturing in two years (with a coupon rate of 8.25%) were still trading at a price of 99.05% and a yield of 9.4% in late May. By June 4, the price had plunged to 91.55% at one point and the yield had spiked to over 20%.

Its longer-term bonds are trading at tighter yields, always a sure sign that investors fear short-term repayment risk. The next hurdle that needs to be cleared is at the end of the month when Evergrande has a $1.5 billion eurobond falling due (after that there are no further maturities until next year).

Recent group announcements suggest that Evergrande’s deleveraging plan is on track. Financially it has been going through “a rough patch” but JPMorgan believes “it will get through”.

BOCI notes that Evergrande has a clear plan to tackle the government’s ‘three red lines’, which it is currently breaching – these are: reported liabilities to assets above a 70% threshold (77% at the end of the 2020 financial year); net debt to equity above 100% (153% in same time period); and cash to short-term debt above 100% (47%).

However, the Wall Street Journal published a bearish analysis this week suggesting that Evergrande’s “frenetic business model” might catch up with it eventually. Its columnist argued that while Evergrande is paying down its debts right now, its “business model requires relentless growth and constant financing”.

JPMorgan suggests that a more positive way to view Evergrande is as an incubator. It argues that its national property development business has given it an “extensive physical presence across the country” which provides it with a “unique low cost platform to try out various businesses”. Aside from the main property unit China Evergrande, the group has three other companies listed in Hong Kong focused respectively on EVs, property management and internet streaming. It is also planning to spin off its property and car sales division.

Over the years, Xu has proven to be an adept operator in the capital markets, which he has used to fund his empire. Can he now rein in his ambitions as he reduces the group’s debt? He has pledged to reduce liabilities from a high of Rmb874 billion in 2020 to Rmb350 billion by June 2023.

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