The Evergrande Debt Crisis
The news that China Evergrande Group, the world’s most indebted real estate property developer, was on the brink of collapse sent global markets tumbling in September 2021. Saddled with more than $300 billion debt,[1] the Chinese property giant has missed four payments[2] (although it recently managed to make two last-minute key payments to bond holders[3]), and is faced with hundreds of unfinished residential buildings and angry suppliers who have shut down construction sites. The company has started to pay overdue bills by surrendering unfinished properties, and it has even asked employees to lend it money.[4] Rating firms like Fitch, Moody’s and S&P have said that Evergrande is running out of cash and time. The property giant still has nearly $338m in offshore coupon payments coming due in November and December.[5] Is failure inevitable?
Analysts have compared the Evergrande meltdown to the collapse of Lehman Brothers,[6] and questions loom about a government bailout and whether Evergrande is too big to fail. This article aims to provide a high-level overview of the Evergrande saga, and an analysis on why the crisis matters.
Background
Evergrande (previously Hengda Group), founded by Chinese billionaire Xi Jiayin in 1996, is China’s second-largest property developer. The company is part of the Global 500, meaning that it is also one of the world’s biggest businesses by revenue.[7] Listed in Hong Kong and based in the southern Chinese city of Shenzhen, Evergrande expanded rapidly during China’s housing boom, buying land and delivering over 1300 housing and luxury apartment projects in more than 280 cities across China.[8]
As residential sales began to dwindle in recent years, Evergrande’s debt increased and the company diversified into other sectors such as electric vehicles, theme parks, football[9] and even bottled water. The property giant employs around 200,000 people and is indirectly responsible for sustaining 3.8 million jobs per year.[10]
So what went wrong?
As early as 2018, the Chinese Central Bank highlighted in its financial instability report that companies like Evergrande could pose a systematic risk to the nation’s financial system. Evergrande pays a lot to borrow: its average financing cost of 8.3% is the higher than the market average of 5.9% interest rate (China Merchant Securities).[11] In 2018 alone, Evergrande had $98bn debt, $44bn of it due by the end of 2019. Part of this snowballing debt links to China’s shadow-banking system. About 45% of Evergrande’s interest-bearing liabilities in the first half of 2020 were from trusts and other shadow lenders, which are opaque with high interest rates. Moreover, Mr Xi Jiayin is member of the Chinese People’s Political Consultative Conference, an elite group of politically well-connected advisers. His connections likely gave creditors more confidence to keep lending money to Evergrande.[12]
Why is Evergrande in so much trouble now?
Evergrande might have been able to keep going had two problems not arisen.
First, Chinese regulators are cracking down on the reckless borrowing habits of property developers. In an attempt to stabilise the booming property market, President Xi Jinping started his mantra that “houses are for living in, not for speculation” in 2017. In 2020, under China’s ‘Common Prosperity’ campaign, regulators took a harder approach, imposing an unyielding crackdown on leverage, especially on developer debt. China’s new three red lines policies require: 70% ceiling on liabilities to assets; 100% cap on net debt to equity; and, cash to short-term borrowing ratio of at least one.[13] Evergrande exceeded all three restrictions, making it insolvent by definition. This resulted in its unsuccessful attempts to sell off some of its business.
Secondly, China’s property market is slowing, eroding demand for Evergrande’s properties. Evergrande has slashed prices on new apartments, but even that has failed to entice new buyers. In August it made 25% fewer sales than it did in 2020.
Impact of Evergrande
Writing in the FT in late August, billionaire investor George Soros warned that an Evergrande default could cause China’s economy to crash. Similarly, Chen Zhiwu, a professor of finance at the University of Hong Kong, said in a New York Times article that a failure could result in a credit crunch for the entire Chinese economy as financial institutions become more risk averse.[14]
The immediate impact of Evergrande’s troubles will be on China’s once booming property market. China’s real estate market has been called the most important sector in the world economy.[15] Valued at $55 trillion, property has become the no. 1 economic growth driver for China, accounting for approximately 29% of the country’s GDP. From the crisis, banks and property companies are likely to restrict building activity and financing as they restructure broken balance sheets, and Chinese households will be wary about taking on new mortgages. Panic from investors and home buyers stemming from the Evergrande crisis could spill over into the property market and hit prices, affecting household wealth and confidence. Beyond the world of property, the collapse of Evergrande would have major ramifications in other sectors it is involved with, including consumer electronics, building materials, furniture and electric cars.
Evergrande’s failure could also shake global financial markets, making it more difficult for other Chinese companies to continue to finance their businesses with foreign investment. It has an enormous web of contractors and other businesses in the region that are owed money from the developer. 128 banking institutions and 121 non-banking institutions are exposed to Evergrande.[16]
For foreign investors, they worry that if Evergrande fails, the money they are owed will vanish. Beijing authorities have indicated that they are no longer willing to bail out foreign and domestic bondholders. In any bankruptcy proceeding, they would be low on the list of creditors to get any of the Chinese company’s assets.[17]
While it is not clear what will happen to Evergrande, the crisis is a reminder to countries worldwide that it needs to closely monitor asset prices and debt levels to preserve the health of an already fragile global economy.[18]
[1] For comparison, Russia’s state debt in 2020 was $257 billion.
[2] https://www.weforum.org/agenda/2021/09/evergrande-debt-crisis-global-economy/
[3] Failure to make the payment would have triggered cross-defaults on all of Evergrande’s $19bn worth of bonds in the international capital markets, in what would have been the world’s second-largest emerging market corporate debt default.
[4] https://www.nytimes.com/article/evergrande-debt-crisis.html
[5] https://www.theguardian.com/business/2021/oct/22/china-evergrande-will-make-crucial-bond-payment-to-avert-looming-default-reports
[6] https://www.cnbc.com/2021/09/22/heres-why-the-evergrande-crisis-is-not-chinas-lehman-moment.html
[7] https://edition.cnn.com/2021/09/24/investing/china-evergrande-group-debt-explainer-intl-hnk/index.html
[8] https://www.weforum.org/agenda/2021/09/evergrande-debt-crisis-global-economy/
[9] Evergrande bought a soccer team, which is now known as Guangzhou Evergrande, in 2010. The team has since built what is believed to be the world’s biggest soccer school, costing $18 million to Evergrande.
[10] https://www.weforum.org/agenda/2021/09/evergrande-debt-crisis-global-economy/
[11] https://www.ft.com/content/6366d4c1-bcad-326f-a221-527a0ca94dc1
[12] https://www.nytimes.com/article/evergrande-debt-crisis.html
[13] https://www.bloomberg.com/news/articles/2020-10-08/what-china-s-three-red-lines-mean-for-property-firms-quicktake
[14] https://www.nytimes.com/article/evergrande-debt-crisis.html
[15] https://www.theguardian.com/world/2021/oct/15/chinas-booming-real-estate-market-could-spell-trouble-for-the-economy
[16] https://www.weforum.org/agenda/2021/09/evergrande-debt-crisis-global-economy/
[17] https://www.aljazeera.com/economy/2021/9/15/what-could-an-evergrande-debt-default-mean-for-china-and-beyond
[18] https://www.weforum.org/agenda/2021/09/evergrande-debt-crisis-global-economy/
