Explainer: How are China Evergrande's debt problems a systemic risk?

China Evergrande Group has provided funds to pay interest on a dollar bond, a person with direct knowledge of the matter told Reuters on Friday, days before the deadline for the developer to plunge into formal default.

The news of the remittances is likely to bring relief to investors and regulators worried about the wider ramifications of the default on global markets, adding reassurance to Chinese officials who said creditors' interests would be protected.

WHAT IS EVERGRANDE?

Chairman Hui Ka Yang founded Evergrande in Guangzhou in 1996.

It is China's second-largest developer with $110 billion in sales last year, $355 billion in assets and more than 1,300 new buildings across the country. It was incorporated in Hong Kong in 2009.

Evergrande has grown rapidly by buying up land with loans and selling flats quickly by low margins. It had 163,119 employees at the end of June, according to an interim report.

The slowdown in growth has led it to move into sectors such as insurance, bottled water, football and electric vehicles (EVs).

HOW DID DEBT-RELATED ILLNESSES ARISE?

In September last year, a leaked letter revealed that Evergrande had pleaded with the government for support to approve a closed listing on the stock exchange. Sources told Reuters that the letter was genuine; Evergrande called it a forgery.

In June, Evergrande said it had failed to pay some commercial papers on time, and in July a court froze a $20 million bank deposit belonging to the firm at the request of a bank.

In late August, the company said construction at some of its sites had been halted due to non-payment to contractors and suppliers. Sources told Reuters that in early September the company had requested an extension to the repayment of the trust loan, and media reports said Evergrande would suspend interest payments on loans to two banks this month.

Liabilities, including payables, stood at 1.97 trillion yuan ($306 billion) at the end of June, equivalent to 2% of China's gross domestic product.

HOW DID EVERGRANDE REDUCE ITS DEBT?

Evergrande stepped up its debt reduction efforts last year after regulators imposed limits on three debt ratios, dubbed the "three red lines". The company aims to meet these requirements by the end of 2022.

It has been offering big discounts on residential complexes to encourage sales and has been selling most of its commercial properties. Since the second half of 2020, the company has held a secondary sale of $555 million worth of shares and raised $1.8 billion through the listing of its property management division, while its electric vehicle division reported a stake of $3.4 billion.

On 14 September, it said plans to divest assets and capital did not result in significant progress.

WHAT ARE THE RISKS?

China's central bank said companies including Evergrande could pose a systemic risk to China's financial system in 2018.

According to the leaked letter, 128 banks and more than 121 non-banking institutions were involved in the firm's liabilities.

Late payments could trigger cross-defaults as many financial institutions are exposed through direct loans and indirect holdings through various financial instruments.

OPERATIONS OUTSIDE CHINA?

In Hong Kong, Evergrande owns an office tower and a residential complex, as well as two nearly completed residential complexes and a vast undeveloped piece of land.

It has spent billions of dollars acquiring stakes in automotive technology developers, including Sweden's NEVS, the Netherlands' e-Traction and Britain's Protean. It also has joint ventures with Germany's Hofer and Sweden's Koenigsegg.

WHAT ARE REGULATORS SAYING ABOUT EVERGRANDE, PROPERTY?

In comments published by state media Xinhua and echoing the central bank, Vice Premier Liu He said at a forum in Beijing on Wednesday that risks could be controlled and that a reasonable demand for capital from property firms was being met.

Yi Huiman, chairman of China's securities regulator, said the authorities would properly manage the risks of default and seek to reduce over-indebtedness more broadly.

Central bank governor Yi Gang said on Sunday that the world's second-largest economy was "doing well" but was facing problems such as default risks for some firms due to "poor governance". And said China would fully respect and protect the legal rights of Evergrande's creditors and asset owners in line with "repayment priorities" set by Chinese law.

WHAT'S NEXT FOR EVERGRANDE?

Evergrande transferred $83.5 million to a trustee account at Citibank on Thursday, a source told Reuters, allowing it to pay all bondholders before Saturday's grace period expired.

However, the developer will have to make payments on a number of other bonds with the next major deadline to avoid default in just a week's time, and little is known about whether it will be able to pay those debts.

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Evergrande missed coupon payments totalling about $280 million on its dollar bonds on 23 September, 29 September and 11 October, starting 30-day grace periods for each.

At the end of the grace period, non-payment would result in a formal default and trigger cross-default provisions on the other dollar bonds. Evergrande's next payment deadline is 29 October, with the 30-day grace period on the coupon expiring on 29 September.