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As at 3pm on 30th July, the price of 2022 USD bond (EVERRE 8.250% 23MAR2022 CORP (USD)) issued by China Evergrande dropped to $55. Earlier in the morning, it had plummeted to a historical low of $50. Given that the bond’s remaining tenor is less than a year, its annualized yield has already exceeded 200%.
News 1: The credit ratings have been downgraded again
On Monday (26th), S&P downgraded Evergrande's issuer rating from B+ to B-. Fitch followed later, downgrading the issuer from B to CCC+ on Wednesday (28th).
In the reports of the two rating agencies, we noticed that the ratings were downgraded mainly because of the severe decline in Evergrande’s financing capacity. The rest of the reports were mostly similar to that of previous rating reports (last publication date: S&P on 30 April, Fitch on 22 June).
With the yields of Evergrande’s short-term debts shooting up to an extremely high level, it is almost impossible for the group to refinance its debt in any way. However, we must note that rating agencies need to consider the issuer's total debt as a whole, including bonds with different maturities. Therefore, even if it is downgraded to CCC+, does it mean that it will default in the short term?
In fact, we have been more optimistic about Evergrande’s short-term bonds, while holding a wait-and-see attitude towards its long-term bonds.
News 2: No special dividends will be distributed
In early July, Evergrande suddenly announced that it would discuss distributing special dividends, causing a stir in the market. For bond investors, the distribution of dividends is a negative event in theory, because it will directly weaken the company's liquidity or assets, and affect its solvency.
At that time, Evergrande may have made this decision to stimulate the stock price. However, in just one month, the situation of Evergrande took a sharp downturn. The group announced on Tuesday (27th) that after it considered "the current market environment, the rights of the shareholders and creditors", they decided to cancel plans for the special dividends.
The Group's actions have shaken market confidence. Investors are worried about whether Evergrande is encountering liquidity problems, so its stocks and bonds have tumbled again. We believe that the non-distribution should be essentially beneficial to bond investors, but the decline in stock prices will also reduce the group's equity financing space, so it definitely is a "double-edged sword", making it difficult to determine if this is good or bad for investors.
News 3: Commercial paper incidents and repaying debts using houses
As Evergrande’s commercial paper incidents continue to mount, many suppliers have pointed out that the group had not repaid its debts as scheduled. On Monday (26th), Huaibei Mining, a state-owned enterprise in Anhui Province, stated that Lu'an Hengda, a subsidiary of Evergrande, had defaulted on project fees of RMB 400 million, and therefore filed a civil claim with the Intermediate People's Court of Lu'an City, Anhui Province to recover the relevant payments. Evergrande referred to the incident as normal contract disputes and stated that legal procedures are in progress.
As Evergrande’s commercial paper incidents continue to mount, many suppliers have pointed out that the group had not repaid its payables as scheduled. On Monday (26th), Huaibei Mining, a state-owned enterprise in Anhui Province, stated that Lu'an Hengda, a subsidiary of Evergrande, had defaulted on project fees of 400 million yuan, and therefore filed a civil claim with the Intermediate People's Court of Lu'an City, Anhui Province to recover the relevant payments. Evergrande referred to the incident as normal contract disputes and stated that legal procedures are in progress.
With negative rumors continuing to circulate, more suppliers who feel unconfident will reduce their tolerance for Evergrande and will be more proactive in collecting payments. Recently, it has been reported that the Group has adopted a new repayment method of "repaying debt with houses". According to these sources, Evergrande allowed its project companies to settle their commercial papers with houses of 60% to 80% of the market price. Suppliers holding commercial papers can sign up to be repaid in such a manner and those transactions can be registered with government housing departments.
Although the news has yet to be confirmed, we think the possibility of this happening is quite high. If Evergrande can indeed negotiate with local suppliers to resolve part of its outstanding commercial papers in this way, it will help reduce the pressure on its short-term liquidity.
We are inclined to believe that Evergrande is capable of employing such a strategy because the payables to suppliers can be repaid in a more flexible way, allowing the existing capital at the group level to be kept to repay standard market debt instruments (such as bank loans and bonds). As the latter must be repaid in cash and could trigger a cross-default of all remaining debts once overdue, it should have higher priority to the group. That is why Evergrande also swiftly settled the China Guangfa Bank incident within two days.
News 4: Holdings on Langfang Development holdings are frozen
Langfang Development issued an announcement on Thursday (29th) stating that due to a civil lawsuit between Xiaogan Gaochuang Investment Company Limited and Hengda Real Estate, the court of Xiaogan City, Hubei Province has frozen Evergrande’s 20% stake in Langfang Development.
Langfang Development is listed in China, with a current market value of about 1.7 billion yuan. The company heating business mainly operates in Langfang City, Hubei Province, and achieved approximately 200 million yuan in revenue last year. Evergrande purchased more shares in Langfang Development in 2016 and became its major shareholder. At that time, the market treated this as competition between Evergrande and the Langfang Municipal Government for shell corporation, which at some point caused Langfang Development’s market capitalization to soar to nearly 10 billion yuan.
In this incident, we have not seen any relationship between Gaochuang Investment and Langfang Development. The court may freeze the Langfang Development shares held by Evergrande only to protect the rights and interests of the petitioner. Evergrande’s latest response pointed out that it is now seeking legal advice on this matter to protect its lawful rights. Therefore, we will need to monitor the situation for subsequent developments before providing further comments.
News 5: Lanzhou Government urges land payment from Evergrande
On Thursday (29th), Natural Resources Bureau of Lanzhou Municipality issued an announcement requiring 41 developers to repay their outstanding land transfer fees. 20 of these developers are subsidiaries of Evergrande; 19 of them belong to the Evergrande Cultural Tourism City project in Lanzhou.
Although Lanzhou city authorities have not announced the actual amount of outstanding payments, we believe that it will not be difficult for Evergrande to deal with it as almost all of them are related to the same project. With reference to the Group’s handling of the suspension of pre-sale permits for its projects by the Shaoyang City authorities last week, we believe that the Group will also discuss the matter with the government as soon as possible.
In addition, there are also other news including local banks in Hong Kong suspending mortgage applications for Evergrande projects and Heze Government’s investigation into the underpricing of Evergrande properties. However, we believe that these two news will have relatively little impact on the market at this point. In view of the negatives news surrounding Evergrande, we have published three other updates in recent months:
- China Evergrande is surrounded by rumours again. What is happening this time?
- China Evergrande is surrounded by rumours again. What is happening this time? (Part 2)
- China Evergrande’s Latest Saga with China Guangfa Bank
As we mentioned earlier, Evergrande’s strength comes from its sales cash inflow and asset portfolio, which are not comparable to other issuers that have already defaulted or in distress. Moreover, the Group's deleveraging pace is reasonable, and there are no onshore and offshore bonds due for the remaining part of the year. With these in mind, we are still optimistic about its short-term bonds.
We will also pay close attention to its July sales figure and interim results to be announced next month, and provide timely updates then.
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Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in EVERRE 7.500% 28Jun2023 Corp (USD) and EVERRE 8.250% 23Mar2022 Corp (USD). The analyst who produced this report holds a NIL position in the abovementioned securities.
