China Evergrande Tests the “Too Big to Fail” Hypothesis With $1B Bond Sale at 11%

Debt-laden developer China Evergrande announced on Monday that it had sold $1 billion in senior notes due in 2020, with the new paper carrying 11 percent interest rates.

The company said that the fresh tranche of bonds, which were issued less than three weeks after the Shenzhen-based home builder had sold $1.8 billion in bonds in an earlier offshore debt issue, were part of a bid to “refinance its existing offshore indebtness,” according to the company’s filing to the Hong Kong Stock Exchange.

Evergrande’s new debt was issued on the same day that another mainland developer, Times China Holdings Ltd also said it is in the process of book building for a two-year bond with initial price guidance at 11 percent, while Shanghai-based builder Greenland Holding Group is taking bids for 1.5 year notes in the low nine percent range, reported Bloomberg.

Developers Reach for Offshore Debt as Beijing Cracks Down

Chinese developers have been caught in a tightening funding squeeze as Beijing pushes forward a deleveraging campaign to reduce the country’s total debt and rein in an overheated property market. To make things worse, the sector is facing a record $62 billion of bonds due in both onshore and offshore markets in 2019, prompting the country’s builders to sell short-term dollar bonds with higher premiums.

Evergrande’s additional notes will be consolidated and form a single class with the $565 million in senior notes that it issued at 11 percent on November 6, which was part of the company’s $1.8 billion bond sale at the end of October, according to the company statement.

Evergrande surprised the bond market on October 31 by selling three tranches of senior notes worth $1.8 billion with interest rates up to 13.75 percent. The company’s billionaire chairman and founder Xu Jiayin subscribed to more than half of the overall issue, a move seen as an attempt to lift investor confidence.

Xu and a wholly-owned company bought $500 million of the $645 million in four-year notes, which yield 13 percent, and the same amount of the $590 million in five-year paper, which carried a coupon of 13.75 percent. The company also sold $565 million in two year notes with a coupon of 11 percent, which will be consolidated into the new $1 billion tranche.

Skimpier Covenants and Higher Coupon Rates

Evergrande, which is known for its aggressive approach to leverage and willingness to take on financial risk introduced a new structure for its $1.8 billion bond deal earlier this month,“which is totally different from the old one,” according to a Hong Kong-based lender cited by the Financial Times. This developer is following the same approach for the $1 billion in notes that it sold this week.

Issued through a British Virgin Islands entity called Scenery Journey, the bond uses a covenant structure which includes its onshore subsidiary Hengda Real Estate Group providing a so-called “keepwell” deed to maintain the issuer’s solvency, without offering a formal guarantee. These deeds have proliferated in China’s bond market in recent years but they are largely untested, according to the industry source.

The lack of security for Evergrande’s creditors appears to fit with a generally erosion in bond covenants in the region, with Moody’s Investors Service stating this week that covenant quality for Chinese developer bond had fallen to its all-time weakest level, according to a recently completed survey by the credit rating agency.

Evergrande said in its statement that it is issuing this set of additional notes to raise fund and that the net proceeds from the approximately $999.3 million borrowed will be used to refinance existing offshore indebtedness.

Ratings Agencies Say Latest Debt Deal Even Junkier

Evergrande’s bonds were assigned a B credit rating by ratings agency S&P – deep into junk-rated territory – and a B2 rating by Moody’s service, as analysts raise questions about risks to the developer’s business, and to China’s real estate sector in general, as home sales slow and the mainland government continues to clamp down on credit.

The Chinese builders’ rush to issue dollar bonds can increase “systemic risk in the form of larger maturity walls that will need to be refinanced,” Paul Lukaszewski, head of Asian corporate debt & emerging market credit research at Aberdeen Standard Investments, told Bloomberg this week. “If the trend toward shorter dated issuance continues, we would not be surprised to see Chinese regulators intervene again much like we saw earlier this year with regards to 364-day issuance,” he said.

Moody’s concluded in its just-released report that the average covenant quality score for Asian full-packaged high-yield bonds fall to all-time weakest level of 3.36. “The weakness in the Q3 score – mainly due to issuance from Chinese property developers – takes Asia’s overall average to 2.71 (moderate) for January 2011 through September 2018,” said Evan Friedman, head of covenant research.

Evergrande, China’s largest property developer by sales, has been under pressure to raise funds. As of the end of June, the company’s offshore debts totaled $16.4 billion even as mainland corporates are finding it increasingly difficult to move funds offshore and the government has restricted access to new onshore bond funding.

The company was said last month to be seeking to raise about $1.5 billion by offering its China Evergrande Center office tower in Hong Kong’s Wanchai district as collateral.