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bond default, risks for investors

The Emerald Bay residential project developed by China Evergrande in the Tuen Mun district of the New Territories in Hong Kong, China on Friday July 23, 2021.

Lam Yik | Bloomberg | Getty Images

China Evergrande has committed “two deadly sins” that have led to the debt crisis it is currently facing – and investors “are definitely sweating,” according to one portfolio manager.

The first “sin” is that the cash-strapped real estate giant has borrowed too much money, says Teresa Kong, head of fixed income at Matthews Asia. Evergrande, the world’s most indebted real estate developer, has over $ 300 billion in liabilities.

The second is that the company has “questionable corporate governance”.

“So when you have the two together, it’s like having a really dry forest and tinder to really ignite,” said Kong, who is also a portfolio manager.

The problems at Evergrande have intensified in recent weeks.

The company has warned investors twice in as many weeks that it could default. On Tuesday, Evergrande said it was at risk of a cross default, which means such risks could spill over to other related sectors.

Evergrande said Tuesday that its real estate sales will continue to deteriorate significantly this month, adding to its serious cash flow problems.

The company has struggled to raise funds by trying to sell various assets, but these have yet to result in any sales, she said on Tuesday.

Contagious effect?

Evergrande is China’s second-largest real estate company in terms of sales.

Analysts are watching for the possibility of wider contagion in the real estate sector and greater financial systemic risks in China.

Kong warned that there was “a lot of leverage” in the system. “That’s why… it’s really important to make sure that there is always cash and that there is always confidence,” she told CNBC’s “Squawk Box Asia” Wednesday.

“Last but not least is definitely making sure there is no more social unrest because Evergrande has a very deep reach.”

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Evergrande has more than 1,300 real estate projects in more than 280 cities in China, according to the company’s website. In recent days, protests from angry buyers and investors have erupted in various cities across China, Reuters reported.

“So they’re all over the place in terms of the ability to deliver goods, and if that’s truncated, we might actually see other issues,” Kong added.

Foreign investors are probably the last priority

Foreign investors holding Evergrande bonds “are definitely breaking a sweat,” Kong said.

The government is clear on its goal of maintaining social stability, which means putting homebuyers first, according to the portfolio manager.

“The first thing you want to do is provide… enough confidence… provide liquidity, so that they can deliver these houses, to these people who made the down payments,” Kong said.

Family investors will likely be the second priority, she said, referring to less experienced retail investors.

“While foreign investors, look, it’s institutional investors who should actually understand these risks. So I think a lot of these investors should consider some kind of modification and extension, which means they might have to reduce their principal or, have their coupon paid off at a much later date, ”Kong said. A coupon is annual interest paid on a bond.

Evergrande has six bonds maturing next year and 10 in 2023, out of a total of 24 bonds issued, according to data from Refinitiv Eikon. Its bonds are also included in various Asian high yield indices.

Evergrande’s shares have fallen nearly 80% this year, and its bonds have fallen as well.