Explained: Why Chinese Real Estate Developers Are Struggling With Dollar Debt

Evergrande’s problems are far from over. On 22 October, Evergrande transferred $83.5 million worth of interest payments to Citibank, and before the default deadline of 23 October, the payment was made to the investors.

In the past few weeks, the company has been guilty of having missed four other separate interest payments but was confident of using the grace period to assure investors, but the trouble does not stop there.

Now, Evergrande faces a new test where investors and lenders would be hoping that the developer facilitates coupon payments worth $148.1 million for the three dollar bonds.

The 30-days' grace period for payments for these dollar bonds ends on Wednesday (10 November). Evergrande had missed the payments on these bonds last month, thus ushering in the grace period.

As was the case for its interest payments last month, investors are betting on Evergrande making the payment at the final hour.

However, assuming the payment worth $148.1 million is made, the real estate group has more payments due on its dollar bonds next month. On 28 December, coupon payments worth $50.43 million and $204.77 on two separate dollar bonds would be due.

Failing to make the payment would usher in another 30-days' grace period ending on 27 January 2022. Further, in 2022 alone, Evergrande has $7.4 billion worth of maturing bonds up for payment, of which $6 billion is for US Dollar Bonds.

Evergrande is not the only real estate developer in China risking defaults on dollar bonds, for many other groups have, for a few years now, depended on offshore borrowing through these bonds to expand.

Now, as the crackdown from Beijing on housing prices and a slowing domestic economy puts pressure on the real estate market in China, developers are not only struggling to sell the existing inventory, but also unable to fund the completion of the projects they sold to the customers.

Thus, they not only threaten the global credit markets but the world economy as well. Already, China’s dollar bonds have lost one-third of their value as per reports in Bloomberg.

However, why did China’s real estate developers accumulate so much dollar debt in the first place?

Firstly, real estate developers make up for a significant portion of dollar-denominated bonds from China. As per Bloomberg compilations, real estate groups in China had $207 billion outstanding in dollar-denominated bonds, accounting for one-fourth of the total dollar-denominated bonds from China.

Evergrande alone has bonds outstanding worth almost $19 billion.

However, most dollar bonds issued by Chinese real estate developers came with a higher coupon rate, reflecting the higher risk, and also meaning it's junk rated.

For instance, one of Evergrande’s dollar bonds offering a coupon rate of 8.75 per cent was traded heavily within the markets.

However, bonds from developers offering a higher yield, or coming with more risk, is a characteristic unique to China where real estate groups make for more than 50 per cent of the high yield index, as compiled by Bloomberg.

The Chinese real estate market was a story of infinite growth for investors. As the country shunned its communist characteristics in the early 2000s to grow more market-oriented, investors started betting on the real estate market, factoring how purchasing a home in China was considered as one of the safest investments.

Also, as more and more people were eliminated from poverty in China, investors hoped that the demand for houses would only go up, ensuring a sustained increase in house prices.

The real estate developers thought on the same lines, thus harbouring expansionist ambitions, and therefore, went for several rounds of funding.

However, after securing bank loans locally, developers had no choice but to turn to offshore markets. Until 2014, developers could not sell bonds inside China and even after the restrictions were lifted, the approval time and other bureaucratic processes did not allow for quick borrowing.

Thus, investor aspirations were met by real estate developers’ expansionist ambitions and a cycle of financing and refinancing began, going from $675 million in annual sales in 2009 to $6.47 billion in 2020, as per Bloomberg compilations.

Today, almost 45 per cent of distressed dollar bonds, risking defaults or with high yields, are with Chinese real estate developers.

Beijing, too, recognised this problem and introduced rules to curb reckless borrowing on part of the developers. However, developers, without the finances to cover their liabilities, and thus looking to borrow more through offshore bonds, were caught off guard, and are now struggling to make coupon or interest payments.

Thus, the lack of freedom to borrow is not only threatening their operations, but also their ability to repay or refinance. International credit agencies are also taking note of these defaults.

In China, the government is not only confident of containing the damage to Evergrande, but is also sure that it won’t spill over to other groups or the economy.

For Beijing, there is a greater incentive in containing the fallout of Evergrande, given more than a quarter of its economy relies on real estate related sectors like construction, raw materials, etc.

Unlike the Americans, Chinese citizens invest a majority of their savings into purchasing houses. Therefore, if the real estate developers continue to default, they would be unable to deliver on the commitments made to the consumers, threatening a social unrest or slowdown in consumption.

For Xi Jinping, looking to secure a third-term, stretching his rule as far as he can, it would be imperative to contain the fallout of the real estate sector, and the first step would be to ensure timely coupon payments from the likes of Evergrande and other developers on the dollar-denominated bonds.