China property crackdown: why surprise victim Country Garden could be worse than Evergrande for the economy
- Country Garden has a lower debt load than Evergrande, but plays a bigger role in China’s sputtering housing market given its wider footprint in lower-tier cities
- Developer faces US$2.5 billion in coupon repayments and bond maturities before year’s end, according to analysts at JPMorgan
An imminent ejection from the benchmark Hang Seng Index and several deadlines in the next few days on principal and interest payments will keep the risk of default elevated and the crisis in focus.
“Country Garden was considered the darling of real estate developers when Evergrande defaulted on its debt back in late 2021, as it had a much better-managed balance sheet,” Alicia Garcia Herrero, Natixis chief economist for Asia-Pacific, said in an August 21 research note. “The rapid worsening of Country Garden’s profitability is a sign of how systemic real estate problems are in China.”
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Country Garden declined to comment when contacted for this story.
The crisis is adding to a string of defaults by major Chinese peers since Evergrande, the world’s most indebted developer with US$327 billion of liabilities, caved in two years ago.
Country Garden crisis ‘could trigger a contagion effect’, analysts say
A collapse of Country Garden could be much more worrying domestically because of its status as a bellwether for mass-market housing in China. About 60 per cent of its sales last year were in the nation’s so-called third-tier and fourth-tier cities, rather than bigger cities such as Beijing or Shanghai.
The company had more than 3,100 projects in development across every Chinese province at the end of 2022, with nearly 88 million square metres (947 million sq ft) of its projects already pre-sold for delivery. Only 31 of its projects at the time were located outside mainland China.
Evergrande had about 1,200 projects completed or under construction as of June 30, 2021, before its financial strains came to a head as Beijing’s “three red lines” policy shut out weak and overleveraged developers from the bond and loan market.
Country Garden, which was among a handful of developers to receive lines of credit from China’s state-owned banks as Beijing reversed course last November, has faced a vastly different environment in recent months.
Why a default isn’t the worst possible news for Country Garden
Contracted sales fell for a fourth straight month in July, shrinking 25 per cent to 12.07 billion yuan. The company also posted the biggest drop in sales among China’s biggest developers, a slump of 59 per cent year on year in July.
Developers have struggled to sell homes in the past two years following the debt crisis that engulfed Evergrande and other developers, with concerns rising about oversupply and declining demand in third-tier cities.
As of the end of last year, more than two-thirds of Country Garden’s projects under development had been pre-sold and about 42 per cent of its land bank for future development was in lower-level provinces, potentially exacerbating its cash crunch.
A failure by Country Garden to deliver pre-sold properties could have a broader ripple effect on the property sector and the Chinese economy, in general, if it further saps consumer confidence.
Nearly half of Country Garden’s liabilities at the end of last year were presale deposits from homebuyers, according to Barclays.
“This not only means that nearly a million households could be affected by Country Garden’s debt issues, but also indicates that Country Garden would need to invest four times the amount Evergrande has done to ensure project completion and prevent pre-sold homes being undelivered,” Nomura analysts including Lu Ting said in an August 14 research note.
“Considering an average completion time of three years, the pressure on Country Garden to deliver these pre-sold homes by the end of 2024 is undeniably immense,” Nomura said.
The confidence hit to homebuyers and investors if Country Garden defaults could be even harder than that delivered by Evergrande, according to S&P Global Ratings, given that the macro environment is very different from three years ago and confidence among homebuyers is very fragile.
“They will think twice when buying,” said Lawrence Lu, senior director and analytical manager of S&P’s China properties and conglomerates team. “Why not wait for a bigger discount? Will I get into trouble if I buy now? Can they deliver homes on time? Why don’t I wait for a sale of existing projects.”
Contracted sales recorded by China’s top 100 developers slipped 33 per cent to 350.4 billion yuan in July from a year earlier, according to Shanghai-based property consultancy CRIC.
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Like other developers, Country Garden was a frequent user of debt to finance its expanding housing portfolio, as well as ventures into areas outside the homebuilding sector, such as hotels and robotics.
The company and its affiliates tapped the onshore and offshore bond markets more than 50 times since the beginning of 2020. It also amassed nearly 160 billion yuan in bank loans as of the end of June – even as its total liabilities hovered around US$190 billion.
However, Country Garden was not as aggressive as Evergrande in expanding outside its core homebuilding business, with its robotics business focused on applications for the construction and hospitality sectors.
Evergrande’s total liabilities topped US$300 billion when it missed payments – and ultimately defaulted – on its offshore debt in 2021 amid a cash crunch. Evergrande had about US$327 billion in total liabilities as of June 30 of this year.
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Another stark difference between Country Garden and Evergrande – and one reason the former was considered a safe bet – was because only about 30 per cent of its liabilities at the end of last year were for accounts payable, including commercial acceptance bills, or IOUs to suppliers, according to an analysis by Barclays. Only about 19 per cent of its liabilities were interest-bearing debt.
By comparison, interest-bearing debt and IOUs to suppliers accounted for about 66 per cent of Evergrande’s liabilities at the end of last year, according to Barclays.
As of the end of June, the most recent data available, Country Garden had onshore and offshore bonds, convertible bonds and loans set to come due within a year’s time of 108.7 billion yuan and longer-term debt of 149.2 billion yuan, or roughly US$35 billion in total.
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By comparison, Evergrande, which has continued to operate while seeking to restructure its debt, had bank borrowings and other debt of about US$86 billion, or about a quarter of its total liabilities, at the end of June – two years removed from the beginning of its financial troubles.
Over the course of this year, Country Garden faces more than US$2.5 billion in coupon payments and maturities of its onshore and offshore debt, according to an analysis by JPMorgan.
“Arguably, the incremental contagion is lower than when Evergrande defaulted, as by 2021 sales, 40 per cent of developers have already defaulted; adding Country Garden would raise the number to 44 per cent,” JPMorgan analysts Karl Chan and Katherine Lei said in an August 9 research note.
Even if it repays its missing coupon payments before Wednesday’s deadline, Country Garden could still find it difficult to continue to borrow money if it faces further liquidity shortfalls.
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While homebuyers may stick to only the strongest state-linked developers, other privately run developers are now likely to be caught between a rock and a hard place – investors and financial institutions could become even more hesitant to extend financial support to them, said Nicholas Chen, an analyst with CreditSights.
At the same time, Country Garden is a major employer, with about 58,000 full-time staff, and its projects provide thousands of additional jobs through suppliers and subcontractors. The company has already shed nearly 12,000 full-time roles since the end of last year as its financial situation deteriorated.
A default could put further strain on China’s working population, where one in five young people cannot find a job.
It would also spell more trouble for suppliers, which have already suffered from a string of developer defaults over the past two years, heightening uncertainties in future trade-payment collections from the developer, S&P said.
“Smaller construction contractors and suppliers are in a much weaker position, with their heavy reliance on selected customers, such as Country Garden,” the credit-rating agency said in an August 16 report.
“With sharp drops in activity and scale in the property market and heightened difficulties on cash collection, many may be forced to exit the market or even face liquidation.”
