China Evergrande defaulted on its debt. Now what? (Published in 2021) (2023)

HONG KONG — For weeks, global markets have watched the plight of China Evergrande, an unstable real estate giant with debts of $300 billion or more that barely seemed able to make the necessary payments to global investors.

On Thursday, three days after the expiration of the deadline that left bondholders with nothing but silence from the company, a major credit rating firm declared Evergrande in default. Rather than resolving questions about the Chinese giant's fate, the announcement only deepened them.

The company, Fitch Ratings, said in its statement that it had placed the Chinese real estate developer in its "restricted default" category. The designation means that Evergrande had formally defaulted but had not yet entered into any type of bankruptcy filing, liquidation or other process that would halt its operations.

It is the nature of the next step - bankruptcy, forced sale or business as usual - that remains unknown. In the United States and many other places, bondholders can force a reluctant company into some sort of reorganization, usually in court, and split the shares.

The company's largely resigned investors are now waiting to see what Evergrande does next, under the advice of a group of state-linked financial types.

"We all expected that Evergrande couldn't pull the rabbit out of the hat," said Michel Löwy, chief executive of SC Lowy, an investment firm that has a small stake in Evergrande's bonds.

“Now the ball is in your court to come up with some sort of restructuring proposal,” he said.

Evergrande did not respond to a request for comment. Fitch said the company has not responded to its own confirmation request on whether or not it has fulfilled an $82 million payment to bondholders due on Monday, prompting the ratings company's action on Thursday.

On Thursday, Fitch also placed Kaisa, another large and struggling developer, in its "restricted default" category after the company failed to pay $400 million to bondholders earlier this week.

These defaults are testing a long-held understanding among foreign investors that Beijing would eventually step in to save its biggest companies.

For years, many investors have poured money into companies like Evergrande based on this assumption. More recently, authoritiesdemonstrated greater willingnesslet companies go bankrupt to control China's powerunsustainabledebt problem

To underscore this point, China's central bank blamed Evergrande's "mismanagement and reckless expansion" for its problems, saying the crisis was confined to Evergrande. Yi Gang, the central bank governor, indicated on Thursday that Evergrande would undergo something akin to a typical reorganization, suggesting a bailout was not in the cards.

“Evergrande risk is a market incident that will be managed properly in accordance with the principles of commodification and the rule of law, and the rights and interests of creditors and investors will be protected in accordance with the law,” he said.

Evergrande has previously said it would "actively engage" with its foreign creditors to come up with a restructuring plan. It is clear, however, that Beijing will play a role. Earlier this week,evergrande saidOfficials from several state-backed institutions joined a risk committee that would help with the company's restructuring.

Beijing has been front and center after previous corporate debacles. Three years ago, Beijinghe took controlof Anbang Insurance Group afterarresting your president, who was behindsent to prisonfor fraud Early last year, local government officials stepped in to take control of HNA, a transportation and logistics conglomerate saddled with debt from expensive foreign acquisitions. Under his direction, the troubled company waspushed to the administration.

Foreign investors buck this trend at their own risk. The Communist Party controls local courts and has a history of allowing foreign investors towith little or nothing.

Investors can look for assets abroad, but the process can be complicated.

“Evergrande is complex and has entities in companies both inside and outside the PRC,” said Daniel Anderson, a partner at law firm Ropes & Gray in Hong Kong.

“There is no single clean legal mechanism that can be put in place to restructure the group,” he said. "As a result, it will have to be cross-jurisdictional, which will make it very complex."

For more than a decade, Evergrande was China's largest developer,coin moneyof a real estate boom on a scale the world had never seen. With each success, the company expanded into new areas such as bottled water, professional sports and electric vehicles.

Eventually, he borrowed too much to pay bills he owed to banks, contractors, and investors. In addition to its $300 billion accounting debt this year, some experts estimate its non-accounting liabilities could be another $156 billion.

Its financial woes are partly the result of Beijing's attempt to cool China's real estate market. Fearing contagion in the wider financial system, regulators have cracked down on developers like Evergrande, forcing them to pay debts to banks and other financial institutions.

Evergrande struggled to sell its vast empire. He failed to sell an electric vehicle businessdespite the conversationswith interested buyers. Experts warned that buyers were expecting a sale.

The housing market downturn and lower demand for new apartments made matters worse.

Evergrande often depended on a pre-sale model of apartments before they were fully built. Some 1.6 million homebuyers were still waiting to move into Evergrande apartments in September, when the company called its top executives together and asked them topublicly signwhat he called a "military order," a commitment that guarantees the completion of hundreds of development projects that have already been sold.

To fulfill that promise, Evergrande needed to pre-sell new properties to raise enough cash to continue operating or find other sources of cash.

Surprisingly, for a few months Evergrande was able to keep paying bondholders. Few thought that Evergrande would last long. Other Chinese developers began to struggle as investors panicked, driving the cost of borrowing to new heights. With limited access to finance amid a broader industry crackdown on lending, more than 11 real estate companies defaulted on their bonds this year.

As his problems worsened, Evergrande spoke less and less about his prospects. To find out if they had made their payments, the financial world turned to bondholders to ask if they had received any money. Inside China, censors suppressed any negative news.

Investors must now wait for any information that Evergrande and Beijing deem worthy of publication.

“The idea,” said Löwy of SC Lowy, “is that we need to understand what the assets really are, what the liabilities are and how the company can survive.”