The Credit Induced Crisis
The tightening of its rules in the real-estate sector  by the Chinese Government, to control the debt levels and speculation, initiated trouble for Evergrande.
- Evergrande, once China’s top-selling developer, which leveraged on the ‘borrow-to-build business’ principle, ran into trouble and its share lost value by 80% during 12 months from Sept 23, 2020, to Sept 24, 2021.
- This China’s second-biggest property developer, had $83.5 million in dollar-bond interest payments due on 23 Sept 2021, on a $2 billion offshore bond, which it failed to pay.
- According to Fitch Ratings and S&P Global Ratings, the $47.5 million dollar-bond interest payment due in the week ending October 2, 2021, seems unlikely to be honoured.
Unless Evergrande settles the interest within 30 days of the scheduled payment dates, both bonds would default, which some fear would trigger a ‘Lehman Brothers moment’ for China .
The Myth of Evergrande being Too Big to Fail
Evergrande expanded from property development to businesses like wealth management, electric cars, theme parks, bottled water, groceries, and dairy products.
- According to Goldman Sachs Group Inc., Evergrande has more than 200 offshore and nearly 2,000 domestic subsidiaries, with assets equivalent to 2% of China’s gross domestic product .
- With more than 1,300 projects spread across 280 cities and with nearly $78 billion in revenue last year, Evergrande is one of the biggest conglomerates in China and featured in the elite Fortune 500 companies.
- Evergrande proved that big companies can also stumble upon their payment deadlines, only that the ripples will be bigger and far-reaching.
With total outside liabilities around $ 310 billion, around $37 billion as interest and principal payments due over the next year, the future of the company without a government bailout, looks bleak.
What Went Wrong?
In China, during 2019 and 2020, while the pandemic induced lockdowns had hurt property sales badly, depriving the company of cash flows, the government’s crackdown on real-estate developers from borrowing beyond the limits known as the “Three red lines” prevented the company from raising new debt. As a result, the company ran into a severe shortage of cash, so much that in summer 2021 the company started paying some suppliers with unfinished apartments instead of cash . Beijing’s restrictions on the property developers’ debt levels which are intended to avert a crisis, virtually initiated one.
The Snowballing into a Catch 22
Without cash, the apartments cannot be completed. Without selling apartments, the company cannot generate cash. Without cash flows, the company cannot pay its debt. The following events snowballed and put the company in a catch 22.
- In August 2020, Evergrande allegedly sent a letter to the provincial government of Guangdong, warning officials that payments due in January 2021 could cause a liquidity crisis and potentially lead to cross defaults in the broader financial sector .
- That alleged letter leaked on social media in September 2021 and sent Evergrande’s stock tumbling in the stock market.
- Though the January crisis was averted, as a group of investors waived their right to force a $13 billion repayment, the company’s debt has been repeatedly downgraded by rating agencies.
- Not only the investors of its wealth management business started asking for their money back, but those who had pre-deposited money to buy flats also started demanding Evergrande to either deliver a flat or return their deposits immediately .
As the Chinese government was showing no intention to help, Evergrande has come up with a plan to cut down on its debt by mid-2023, through a series of asset sales and stock offerings. The company explored the listing options for its tourism business and possibly the water business too, but the efforts weren’t enough. Since January 2020 the company didn’t sell a single dollar note but raised $ 8 billion till August 2021 by disposing of its holdings in its EV unit, Heng Ten, and a regional bank.
Effect on the Chinese Economy
Around 29 % of China’s GDP is from its real estate. The fall of Evergrande certainly worries the Chinese government, the biggest being the potential spill-over effect hitting the country’s economy that is just recovering from the COVID aftermath. The worsening geopolitical relationship with the west and the government getting too assertive with the private entrepreneurs had already triggered fears of a sustained slowdown of the economy.
Only a Tip of the Iceberg
Allegedly, Evergrande owes money to about 171 banks and 121 other financial firms  in China who will eventually take a hit if it fails. This could result in a credit crunch depriving funds for new investments. According to UBS Asset Management, there could be another 10 developers with potentially risky positions with combined contract sales of 2.7 times that of Evergrande. In other words, Evergrande could be only the tip of the iceberg. Unless Beijing steps in to bail out Evergrande, which it is now it is reluctant to, the fallout could spill into other sectors of the economy as well.
The International Spillover 
Its growth pivoted on civil engineering; China happens to be the biggest steel importer in the world. If China’s real estate is badly hit, steel exporters from countries like India will be affected and their shares can take a hit. Evergrande has already pulled down almost every equity index in the world in that week by over two percentage points  and decimated the commodity prices. For the world economy which is recovering from the effects of the pandemic, China being the world’s factory, its economy slowing down would be bad news.
Need Not Be a Lehman Brothers Moment 
The Evergrande crisis is different from Lehman Bros in 2008. Unlike the Evergrande, Lehman operated in a free market. Lehman’s fortunes ended when banks refused to lend to it. The bulk of Evergrande’s liabilities are with domestic financial institutions and China’s almost entirely state-owned banking sector can withhold credit from Evergrande only so long as it starts hurting its own economy.
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Do you think the government is doing enough to impose responsibilities on builders in India? Why?
Do you think that a more balanced capital structure (lower debt-equity ratio) would have averted the crisis for the company?
#BEL #FAF #Evergrande #WealthManagement #Economy
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