This article is from the Australian Property Journal archive
NUMEROUS sectors could be exposed to heightened credit risk if Chinese development giant Evergrande was to default, according to Fitch Ratings, although the likelihood of a significant impact on house prices remains low.
One of the three biggest developers in the country, Evergrande is currently bearing the weight of US$300 billion – about $409 billion – in total liabilities.
It has 1,300 developments in 280 cities across the country. Some 1.5 million people have put cash into Evergrande for apartments that may never be built.
“We believe a default would reinforce credit polarisation among homebuilders and could result in headwinds for some smaller banks, although we believe the overall impact on the banking sector would be manageable,” Fitch’s Samuel Hei, Elaine Xu, Andrew Fennell and Duncan Inner-Ker said.
Fitch last week downgraded China Evergrande Group from CCC+ down to CC, indicating it views a default of some kind as probable.
“Mounting investor concern about Evergrande’s creditworthiness has already exacerbated credit polarisation among developers, which has left those with weaker credit metrics struggling to tap debt markets at sustainable interest rates, increasing refinancing risk,” they said.
Beijing introduced the “three red lines” for property developers last year, which imposed limits on liabilities as a share of assets, gearing of under 100% and enough cash to cover short-term debts. Standard & Poor’s estimated just 6% complied with rules at the beginning this year.
While Evergrande has a podium place among China’s developers, the country’s highly fragmented market means its market share in 2020 was only around 4%.
“We believe the risk of significant pressure on house prices in the event of a default would be low, unless the restructuring or liquidation of its assets becomes disorderly. Fitch believes this is something the authorities will want to avoid,” Fitch said.
The government’s priority in a default scenario would be being the completion of Evergrande’s sold projects, Fitch believes.
“Debt associated with the project companies is typically manageable, but we expect potential acquirers would still want to prevent any adverse impact on their operations – or creditworthiness – given tight industry funding conditions.
Banks have direct loan and bond exposure to Evergrande, and exposure to off-balance-sheet wealth-management products, through trust loans. Its liabilities in these areas amounted to about CNY572 billion at the end of June, much of which is believed to held by banks and other financial institutions.
“Banks may also have indirect exposure to Evergrande’s suppliers – the developer’s trade payables stood at CNY667 billion. Smaller banks with higher exposure to Evergrande or to other vulnerable developers could face significant increases in non-performing loans (NPLs), depending on how any credit event involving Evergrande develops.
Growth in banks’ residential mortgages and property development loans decelerated the first half of the year following the introduction of new regulatory caps in January. Fitch’s baseline assumption is that this trend would not be affected by an Evergrande default, with banks continuing to curb property-sector exposure in order to meet regulatory requirements.
At a macro level, an Evergrande default could damage consumer confidence if it were to affect households’ deposits for homes that have not yet been completed, but the government would assumedly act to protect households’ interests.
“Risks to our growth outlook on China are mitigated by the government’s capacity to intervene with policies to shore up the housing market, but we believe the threshold for such support will be high – as it might set back other priorities such as reducing real-estate lending concentration and tackling the high cost of housing.
