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Evergrande: The Crisis No One Wanted

Updated: Dec 18, 2021



Written by: Rohen Veera


What is Evergrande?

Evergrande Real Estate Group is the second-largest property developer in China by sales (Bloomberg, 2021), ranked 122nd on the Fortune Global 500. It is incorporated in the Cayman Islands and headquartered in the Houhai Financial Center in Nanshan District, Shenzhen, Guangdong Province, China. Founded in 1996 by Xu Jiayin, it sells apartments primarily to upper and middle-income dwellers. In 2018, it became the most valuable real estate company in the world (Bloomberg, 2021).


The Problem with Evergrande

In 2021, snowed under its crushing debt of $300B (Wang, 2021), Evergrande is so huge that the fallout from any failure could hurt not just China's economy, but the contagion could spread to markets beyond China. Evergrande has not been paying its suppliers and warned investors that it could default on its debts. Property sales have been dropping significantly in September (Wang, 2021), making its cash flow situation dire. Banks have stopped lending credit and rating agencies have downgraded the firm, citing its liquidity problems (Wang, 2021).


Evergrande’s Debt

Out of Evergrande’s $310B debt, it is estimated that $85B comes from bonds and loans from banks (Wang, 2021). These are the liabilities on which Evergrande pays interest. $67B comes from shadow banking systems; money from unofficial sources, $158B is the most important part, as it is for accounts payable. When Evergrande develops real estate, they need to buy the materials and resources needed. However, they did not pay their suppliers in cash. It went down entirely as accounts payable, thus accumulating debt.


Evergrande Stock Market Information

  • Listed as (3333.HK)

  • Peak trading price was at 27.99 HKD on 30th June 2020

  • Currently trading at 2.25 HKD

  • The stock has dropped 91.96% since

(TradingView - “Evergrande Stock Chart”, n.d.)




Figure 1: Evergrande’s share prices

Source: TradingView


What is also concerning is how the bonds of Evergrande’s real estate counterparts are also dropping sharply, signalling a potential crash.



Figure 2: Fantasia’s Share Prices

Source: TradingView

https://www.tradingview.com/ideas/fantasia/


Evergrande’s counterpart, Fantasia Holdings Group Co Ltd, has also been affected by its liquidity crisis, with share prices falling to 0.355 HKD (as seen in Figure 2). This will have terrible consequences to the entire Chinese real estate market, as it is considered the bedrock of its economy.


Ripple Effects

Many parties will be affected, such as Banks, suppliers, home-buyers, and investors. A possibility of a cross-default may also arise as the inability to repay its debts - where a default triggered in one situation may spread (Shen et al., 2021) to other obligations, leading to a broader contagion.


i) Banks

The banking industry would be severely hit if there are any contagion effects on the wider property sector in China.


ii) Homebuyers and Investors

Hundreds of investors will ultimately still be at a loss, even during an event of a bailout. Since the assets will be sold for pennies on the dollar (Handwerker, 2021).


iii) Suppliers

According to S&P Global Ratings, Evergrande has been trying to settle its debt with physical properties as payment, allowing them to preserve cash for loan repayments.


In an August report, S&P estimated that over the next 12 months, Evergrande will have over 240B yuan ($37.16B) of bills and trade payables from contractors to settle — around 100B yuan of that amount is due this year.


A paint supplier to Evergrande, Shanghai-listed Skshu Paint, said in a filing that the real estate firm repaid part of its debt in properties – and uncompleted ones at that.


Financial institutions and suppliers rely heavily on Evergrande, leading to companies going bankrupt if they are not paid. This is essentially a domino effect of the entire Chinese market, with Evergrande at the centre of it (Handwerker, 2021). Additionally, we also need to think of Evergrande’s employees, which has over 123,000 employees alone, and that does not include the number of construction workers who are hired for each of their projects.


The Next Lehman Brothers?

Evergrande’s situation brings back ghosts of our past, such as the Lehman Brothers Collapse, that cascaded into what we know now as, the 2008 Housing Crisis. The table below compares both situations.

Lehman Brothers

Evergrande

A Fire Sale occurred over a long period.

A Fire Sale occurred over a short period.

Credit Markets are frozen.

Credit Markets are not frozen.

Different Asset Classes were being sold off for a few days.

Not an aggressive sell-off.

Terms and Definitions

i) A Fire Sale consists of selling goods or assets at heavily discounted prices (Kenton, 2021).

ii) Credit Market refers to the market through which companies and governments issue debt to investors, such as investment-grade bonds, junk bonds, and short-term commercial paper (Mitchell, 2021).

iii) In an Asset Sale, a firm sells some or all of its actual assets, either tangible or intangible (Hayes, 2021).


From the analysis above, Evergrande is not Lehman Brothers, even though it owns assets with artificial valuations. Hence, we do not need to fear the past from repeating itself.


Hidden Risks

The figures in the books sometimes do not tell the full story. Since the clamping of Beijing began on corporate debt, real estate developers utilised off-balance-sheet vehicles to borrow money and skirt regulatory scrutiny. A popular choice of using joint ventures, allows companies to keep details of its debt off its balance sheet (Shen et al., 2021).


Nomura estimates that Chinese developers owed 33.5 trillion yuan ($5.24 trillion) through various channels (Shen et al., 2021). Also, private bonds issued by shell companies in offshore locations have emerged as a new concern. This would mean that the true extent of Evergrande’s liquidity problem is unknown.


Possible Solutions

From a macroeconomic perspective, I believe these solutions would alleviate the stress on the financial system in China. This would not solve the problem entirely, but it will decrease the economic impact on China.


i) China’s Banking System

Beijing controls the country’s banking system to a degree that goes far beyond bank regulations in the West. Control of the banks also gives Beijing access to their large pool of money from the country’s deposits, providing a thick financial cushion (Bradsher, 2021). The government would have enough liquidity to bail out Evergrande if it defaults.


ii) Border Control

China strictly controls the movement of money across its borders. Chinese and global investors cannot head for the exits if they get worried. These controls helped insulate China from an Asian financial crisis in 1997 and 1998 that heavily damaged other regional economies, and will do so again, for Evergrande (Bradsher, 2021).


iii) Control of the Courts

The Communist Party firmly controls the courts, so any effort to force Evergrande into bankruptcy and take it apart would need approval from top leaders. Authorities can avoid a rushed sell-off (Bradsher, 2021) like Lehman’s in 2008, which could result in fire-sale prices for Evergrande’s land, apartments, and other collateral, along with huge layoffs.


Conclusion

As economists, we can only predict macroeconomic events with the variables, and data available to us. It is currently too early to say how the situation in China will unfold. Looking at the characteristics of the Chinese government, we can give an estimate that they may allow Evergrande to fail, in accordance with their beliefs of “common prosperity”. However, as the world’s second-largest capital market, which also follows a Marxist-Leninist philosophy, I highly doubt that they will allow it to fail, and push China’s economic growth 10 years behind.


References

Bloomberg. (2021, September 14). China Evergrande Group.

https://www.bloomberg.com/profile/company/3333:HK


Bradsher, K. (2021, September 26). How China Plans to Advert an Evergrande Crisis. New York Times. https://www.nytimes.com/2021/09/26/business/china-evergrande-crisis.html


Handwerker, N. (2021, September 16). Is China’s Evergrande Group Too Big to Fail? The Diplomat. https://thediplomat.com/2021/09/is-chinas-evergrande-group-too-big-to-fail/


Hayes, A. (2021, September 20). Asset Sales. Investopedia.

https://www.investopedia.com/terms/a/asset-sales.asp


Kenton, W. (2021, October 23). Fire Sale. Investopedia. https://www.investopedia.com/terms/f/firesale.asp


Mitchell, C. (2021, May 29). Credit Market. Investopedia.

https://www.investopedia.com/terms/c/credit_market.asp


Shen, S., Jones, M., & Jim, C. (2021, October 21). Analysis-What lies beneath? Hidden debt fears feed China's property woes. Yahoo News. https://sg.news.yahoo.com/analysis-lies-beneath-hidden-debt-230430882.html


Tan, W. (2021, September 16). China's embattled developer Evergrande is on the brink of default. Here's why it matters. CNBC. https://www.cnbc.com/2021/09/17/china-developer-evergrande-debt-crisis-bond-default-and-investor-risks.html


TradingView. (n.d.) “3333 Stock Price and Chart — HKEX:3333 — TradingView.” https://www.tradingview.com/symbols/HKEX-3333/


Wang, M. (2021, September 19). The Evergrande Crisis Explained for HKEX:3333. Today UK News. https://todayuknews.com/market/the-evergrande-crisis-explained-for-hkex3333-by-michael_wang_official/