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Is Chinese Juggernaut Evergrande Too Big to Fail? What Happens If It's Not?

The most indebted real estate developer in the world is struggling to pay its debts and has warned investors it may default. China’s Evergrande owes creditors $300 billion, including would-be homeowners who have paid over deposits for homes in unfinished developments as well as hundreds of suppliers, some of whom have reportedly been paid in unfinished property.



What’s next for the real estate steamroller? Here’s what you need to know:



What Is Evergrande?



Evergrande is more than a real estate developer. Since he began the company as Hengda Group in 1996 in Guangzhou, southern China, founder Hui Ka Yan has diversified its operations into such areas as wealth management, electric vehicle manufacturing, consumer goods production, and healthcare, among others. The group employs over 200,000 workers, but it claims to create as many as 3.8 million jobs annually.



Evergrande is still known primarily for its real estate activities, however, and ranks as China’s second-largest property developer by sales. It owns over 1,300 real estate projects in over 280 Chinese cities and manages nearly 2,800 real estate projects across more than 310 cities.



How Did Evergrande Land in Trouble?



Evergrande borrowed aggressively to acquire assets and grew quickly during China's boom. However, it was already beginning to experience liquidity problems when Beijing introduced caps on debt to cash flows, assets, and capital levels for large developers in efforts to restrain their borrowing costs last year. Those measures placed even more pressure on Evergrande, leading it to sell properties at significant discounts to secure cash flow and keep afloat. But sales have been declining steadily for months now.



In August, S&P placed Evergrande’s payables at $37.16 billion, 40 percent of which is due this year. It has now reportedly reached an agreement over a $35.9 million interest payment on a domestic bond but has an offshore bond payment of $83.5 million still due. It’s also apparently missed two bank payments and is repaying wealth management investors and suppliers with property.



Evergrande’s share price has fallen almost 80 percent so far this year, and trading of its bonds has been halted by Chinese stock exchanges repeatedly recently.



Why Is Evergrande’s Collapse Important?



If Evergrande were to enter bankruptcy, at least 200,000 workers would find themselves unemployed. Investors with holdings of Evergrande stocks and bonds would have to write off their investments. And any prospective homeowners who paid deposits for unfinished developments would lose their money.



Several banks in Hong Kong have already refused loan extensions to buyers of two incomplete Evergrande developments. Those suppliers and contractors with monies dues from Evergrande would have to absorb the bad debt, which may, in turn, send some of them into bankruptcy.



And most importantly, if Evergrande fails to repay the money it supposedly owes to almost 200 domestic banks and other financial institutions, it could trigger a credit crunch, thereby shackling China’s whole financial system. Lenders would be forced to reduce their lending, and the cost of borrowing money will skyrocket. Without access to affordable finance, many businesses won't be able to continue operating.



Will Beijing Step in?



Ultimately, a collapse of this size would undermine domestic and foreign confidence in China. And most experts agree that China’s government is unlikely to let that happen, especially in the lead-up to the 2022 National Congress of the Chinese Communist Party. Social unrest is a big concern, and there have already been protests by disgruntled homeowners and investors.



Given Beijing’s recent efforts to rein in corporate debt, a high-profile bailout is unlikely, say analysts. It would set a bad precedent. Instead, it's more likely the government will find a way to ensure Evergrande's core business survives via some kind of restructuring arrangement.



That could mean other developers take Evergrande’s unfinished developments in exchange for a share of its land bank. This strategy might keep deposit payers and suppliers happy, but it's likely to be at the cost of offshore investors. And what’s a near certainty is that Evergrande’s management won’t be retained.



Will Evergrande Affect US Markets?



There is talk that the Evergrande failure could spread to other markets outside of China. In an interview with CNBC, Ed Yardeni of Yardeni Research explains this is unlikely. For one thing, he’s confident that Evergrande is indeed too big to fail and that Beijing will step in.



He compares Evergrande to Long-Term Capital Management's near-collapse in 1988. Long-Term Capital Management was a hedge fund with $126 billion in assets, and its collapse might have triggered a global financial crisis. But Yardeni points out that the Fed and certain banks stepped in quickly, and all that resulted, in the end, was a sorely needed correction. He's doubtful even that will come out of Evergrande but is confident it won't have any effect on global markets and very little even on China's.

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