Saturday September 11th 2021
The clock is ticking
How dangerous is China Evergrande?
From Stefan Schaaf
The Chinese real estate giant Evergrande is threatened with collapse in the face of its huge debts. That would have far-reaching consequences. “Capital” answers the most important questions.
Who is Evergrande anyway?
Evergrande is first and foremost a real estate developer, you could also call it a property developer. The Evergrande Real Estate Group, which was once called the Hengda Group, has its origins in the southern Chinese province of Guangdong and is officially located in the economic metropolis of Shenzen, in the vicinity of Hong Kong. The holding, a major bond issuer, is based in the tax haven of the Cayman Islands. Some subsidiaries such as Marvel First, Solution Key Holdings or Action Boom are located on the British Virgin Island, which is also a so-called offshore financial center. The Refinitiv database contains 248 companies that are linked to the Evergrande Group or are subsidiaries of the group.
What significance does Evergrande have for the Chinese real estate market?
Evergrande is the second largest real estate company in China after Dalian Wanda and primarily develops apartments for people with middle and higher incomes. Typically, the apartments are sold against prepayment and only then built. The great demand for real estate and the sharp rise in prices in recent years make this possible. The procedure is different from that in Germany, where property developers typically pay in advance and are paid in stages by the home buyers as construction progresses. Evergrande benefited from the long booming real estate market in China, which is an important factor in the economic growth of the People’s Republic.
What else is Evergrande doing?
Because the core business was apparently no longer profitable enough or even to disguise its problems – there is still no clarity – the company expanded into areas such as electric cars, mineral water or baby food. According to specialist media, Evergrande is currently trying to sell its recently acquired electric car division. Among other things, the Swedish electric car manufacturer Electric Vehicle Sweden was taken over in June 2020. This is the successor company to the legendary Saab brand. It was supposed to act as a contract manufacturer for the Sion and Sono Motors brands. The soccer team Guangzhou Football Club, which was once called “Guangzhou Evergrande” and signed Lucas Barrios from Borussia Dortmund in 2012, also belongs to the conglomerate, which is considered to be opaque.
What problems does the company have?
Evergrande’s core business is based on the ever-increasing demand for apartments in China – and on the expectation that apartment prices will continue to rise. There have recently been setbacks in both: Similar to domestic technology companies, the Communist Party is also tightening its thumbscrews on the real estate market. The increase in rents is to be limited, as is the possibility of buying apartments. In some provinces, for example, married couples are only allowed to buy one apartment together. According to media reports, married couples have already divorced so that both can buy an apartment, which has once again resulted in stricter regulation. With the regulatory intervention, Evergrande’s business model no longer works as it did in the past. At the same time, it is considered the world’s most heavily indebted real estate company. It has roughly $ 300 billion in debt. In addition to bonds, these are loans from Chinese banks and financial ties within the group, which are difficult to understand. This lack of transparency in debt and its possible collateral could be a far bigger problem than the sheer burden of debt itself.
What was the trigger for the latest price slide?
Evergrande shares, which are listed on the Hong Kong stock exchange, have been under close scrutiny for some time. As early as 2017, shortsellers had their eyes on the share, that is, they bet on a price slump. If they persevered, they could get rich this year, because the share has lost around three quarters of its value since the beginning of the year. Evergrande was already in arrears with coupon payments in June. The crash accelerated last week after the company announced it might be unable to meet its financial obligations. The rating agency Fitch also caused unrest, downgrading its credit rating for Evergrande to “CC” from “CCC”, which means that it is only seen just above a payment default. Moody’s and smaller rating agencies had previously made similar statements.
How likely is a breakdown?
The company’s bankruptcy “appears likely,” said Fitch. According to Moody’s, debtors have “poor recovery prospects” in the event of a breakdown. In other words, the rating agency no longer expects the debtors to get all of their money back if it goes bankrupt. A bond from the company that ran until January 2023 was only listed at a third of its face value on Thursday before it was suspended from trading by the stock exchange. Whether it goes bankrupt now depends on whether Evergrande can refinance its bank debt quickly and obtain liquidity, also to pay its interest. Ultimately, the decision could be in the hands of the central bank and thus the political leadership in Beijing. It is puzzled whether it wants to make an example or ensure economic stability.
Can Evergrande spark a new global financial crisis?
Investors are currently pondering whether an Evergrande debacle could impact global financial markets. The danger comes more from the bonds and bank loans than from the stocks. Three quarters of these are in the hands of company founder Hui Ka Yan, who was named the richest man in Asia by Forbes magazine in 2017 with a net worth of around 45 billion dollars. The remaining shares are also largely in Chinese hands. The ten largest shareholders in Evergrande Goup include some Western fund companies such as Vanguard and Blackrock Institutional Trust. They only hold 0.63 and 0.25 percent and should be able to put up with a collapse. The Norwegian sovereign wealth fund also holds a small share of 0.21 percent. This and Blackrock have recently already reduced their stocks. So while stocks pose little threat to global markets, the bonds outstanding pose a risk.
How dangerous are the Evergrande bonds?
This question is likely to be bothering many investors at the moment. Evergrande has a total of 24 bonds outstanding with a volume of 26.6 billion dollars, the longest term runs until 2026. No repayments are due this year, but around 7.7 billion dollars in 2022 and 8.6 billion dollars the following year. Coupons still come up. The risk lies not only in a default, which in the case of dollar-denominated bonds is likely to affect institutional investors, but also emerging market bonds held by private investors. The company has to pay $ 129 million in interest this month. A total of $ 850 million in coupons will be due this year. If the company missed its interest payments, this would be assessed by the rating agencies as a payment default and would likely trigger contagion. The big risk is the confusion of the conglomerate. As a result, it is not possible to estimate where the payment default actually has an impact, which securities exist and whether they are of any value at all. In addition, it is not known who exactly holds the bonds and which Chinese banks have issued loans and whether there are claims and liabilities to group subsidiaries. While many investors could put up with the sheer failure of the bonds, this uncertainty about Evergrande’s financial interdependence is a great risk of contagion. A financial crisis cannot therefore be ruled out. This does not have to become global, but it could shake China. How severe the consequences would be also depends on Beijing’s political will to intervene.
This text appeared first at “Capital”.
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