Evergrande Real Estate Group is a big part of that and, at one point, the company was the largest property developer in China.
Who’s Evergrande?
- The real estate industry is one of China’s largest industries as it accounts for as much as 29% of China’s entire gross domestic product.
- Evergrande Real Estate Group is a big part of that and, at one point, the company was the largest property developer in China.
- But now, based on current estimates, the company is the most indebted property developer in the world with over US$300 billion in bad debt, which is debt it probably can’t pay anytime soon.
- In fact, the company has about US$7.4 billion of repayments coming due next year, and even though it has been offering steep discounts on its properties and other assets it owns to try and generate cash as soon as possible, their sales still fell 26% in August from last year.
- And, so far, the Chinese government has stayed pretty quiet on whether it will help the real estate group out as it did for Huarong.
What’s going on with Evergrande?
- Evergrande has accumulated a significant amount of debt because they kept developing the real estate market in China. But, when they were developing it, the company wasn’t using their own money, explained Dr. Tenpao Lee, a professor of economics at Niagara University in New York to TMS.
- “For example, they used a little bit of money to acquire land … and they use a down payment from the buyers and then borrow money from the bank and then acquire more land.”
- But the problem is that the industry started being a bit too overdeveloped, with an oversupply of housing projects and less demand, meaning that the property prices started to fall, which meant that Evergrande had less money coming in and so less money to pay off their liabilities.
- Just for a bit of context, around 20% of China’s total housing is currently unoccupied.
Why does this have such economywide consequences?
- Many actually didn’t think Evergrande could get into this position due to the connections and power of Evergrande’s founder Xu Jiayin, who stepped down as chairman of the company in August of this year with little notice or warning.
- But Lee explained that because the real estate industry is so intertwined with other sectors of the economy, the performance of Evergrande has a chain reaction.
- “Nowadays, all the sectors are interrelated, so real estate is interrelated to other industries as well. In this case, the banking industry because there are over 200 banks that are involved [with Evergrande]. So if the real estate sector is falling apart, then the Chinese economy, the whole country may [be set back] five years. This is because China took 40 years to grow, become the second-largest economy of the world. So, the chain reaction to this is enormous.”
- But the consequences extend beyond China as well.
- HSBC’s asset management and BlackRock Inc. and UBS Group AG are all large holders of Evergrande debt, so if Evergrande can’t pay them, then they get impacted as well. In the last decade, Credit Suisse Group AG has also helped arrange over US$4 billion of debt funding for the developer between them and their asset managers, hedge funds and their wealthy private clients.
What’s the current response?
- In September, Financial regulators in Beijing sent Evergrande quite general instructions: Focus on finishing your unfinished construction projects, pay back individual investors and try to avoid defaulting on dollar bonds.
- This isn’t just a small company that may go bankrupt, as comparisons are being made to the United States investment bank Lehman Brothers collapse in 2008. But, most experts believe that this comparison is a bit of an exaggeration.
- Rob Carnell, regional head of research for Asia-Pacific at ING, believes that this situation isn’t anything like the Lehman Brothers situation that led to the 2008 global market crash.
- “Let’s face it, this is not Lehman’s,” Carnell said to CNBC. “It’s not a hedge fund with massive leveraged positions or a bank whose financial asset prices are hurtling toward zero. It’s a property development firm with quite a lot of debt, you know, 300 billion-plus thereabouts in dollar terms.”
- Larry Hu, a chief China economist at Macquarie, assured people that if they bought a house or apartment with Evergrande that hasn’t been built yet, they should move into their homes after government assistance comes into play.
- “Policymakers would choose to wait first, then step in later to ensure an orderly debt restructuring,” he said. “A wholesale bailout is not very likely and shareholders/lenders might take a big loss. But the government would make sure that the presold apartments get done and delivered to homebuyers.”
What’s next?
- Many are predicting this to go in two directions: full liquidation or debt restructuring.
- Full liquidation basically means that the company would be completely dissolved as the bad debt is offloaded into other government entities to complete the unfinished projects and pay off the bonds.
- Debt restructuring would mean that Evergrande would just move around some money between them and other companies, but Evergrande would still exist at the end of it all.
- Lee explained that he doesn’t see a quick solution for this, but he also thinks that government help needs to be further defined. “I think it depends on how you define ‘bailout.’ I think, right now, the Central government, they will probably ask the local government to help.”
- Citing the Chinese government’s push for “Common Prosperity,” Lee explained, “[Evergrande] is the rich people … So the government is not going to officially say, ‘Oh I’m going to bailout this company, bail out the rich people.’ But on the other hand, we have so many ordinary people involved.”
- With that, Lee thinks it will be a combined effort with losses taken on by everyone involved. “I think it is likely that the Central government will ask the local government to help … buyers and suppliers will both take some loss, and together they can complete the project.”
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