Welcome back. Just a quick video today on Evergrande, the struggling Chinese property
developer. There is a lot of news asking if the collapse of Evergrande will be Chinas
Lehman Brothers moment. Lets discuss. So, Evergrande, is a huge company. It is
China's second-largest property company and the worlds most indebted property developer;
they have liabilities of over $310 billion. So, it is a big deal. In 2018 when Chinas central bank
put together a list of companies that might pose systemic risks to the nation's financial system,
Evergrande was near the top of that list. The stock is down around 80% year to date,
and the company appears to be insolvent. Now, what might surprise you is that the company
has never reported a loss and they have had current assets greater than current liabilities
in every accounting period in the company’s history. So what is going on?
Well, Investors became worried about Evergrande around this time last year
when a leaked letter from the company showed that they had begged the government for support to
approve a now-dropped backdoor listing plan. The company claims that this letter was a forgery.
The leaked letter said that the company’s liabilities involve more than 128 banks
and over 121 non-banking institutions. They admitted this Tuesday that they are
under "tremendous pressure" and may not be able to meet their debt obligations.
For a borrower of their size, late payments on these debts could trigger cross-defaults as many
financial institutions have exposure to Evergrande via either direct loans or due to indirect
holdings through different financial instruments. The idea is that a large financial institution
could well be relying on receiving a payment from Evergrande to make a payment on its own debts.
It is not just the banks that might have problems. Evergrande relies heavily on
customers paying for apartments before the projects are completed to finance construction.
Hundreds of thousands of Chinese people have put down deposits on homes that might never be built.
Bloomberg reports that investors have made down payments on approximately 1.5 million properties.
They will owe a lot of money to suppliers too, who could go bankrupt iff they are not paid.
Additionally, Evergrande has a wealth management affiliate that offers financial products to
Chinese investors backed by the company’s credit. They are renegotiating these loans right now.
Evergrande is also a major employer, it’s collapse would have a severe
impact on the job market in China. The company has 200,000 employees and hires 3.8 million people
every year for project developments. These problems obviously don’t come at a
good time for China investors, coinciding with the Chinese government regulatory drive against
big tech, the for-profit education industry, the real estate industry and other sectors.
Over the last few days, angry protesters have been gathering outside the company headquarters,
demanding information. Investors are growing increasingly nervous that if Evergrande were
to collapse, there could be a domino effect causing other property developers to fail,
creating systemic risks for the banking system of the world's second-largest economy.
Real estate is one of the major engines of China's growth. It’s responsible for 29%
of economic output, and a bankruptcy of this size would have major repercussions.
Many analysts are arguing that there is no way that Beijing would allow
such an important company to go under as it would undermine the regime's stability.
So what went wrong? Well the company burdened by a
mountain of liabilities of more than $310 billion after years of borrowing to fund rapid growth.
They stepped up acquisitions in recent years, taking advantage of a real estate frenzy.
In August of last year, the Chinese Government introduced new measures to monitor and control
the debt level of major property developers. This crackdown forced Evergrande to offload properties
at increasingly steep discounts – reducing prices by up to 25% in order to deleverage.
One of the biggest problems for Evergrande, (which is a general problem in China) is that the reason
the company is struggling having never reported a loss, is that bad investments in China are never
written down. If a company like Evergrande never acknowledges losses, they just show up on the
balance sheet as inventory. And Evergrande has a lot of inventory on its balance sheet. Inventory
that can’t be liquidated to pay off debts, because there is very little of value there to sell.
At this point everything that can be sold has been sold or pledged against specific debts.
Early on when the company was growing a lot the shortfall could be filled with
increased borrowing. Their inventory includes undeveloped land, work in progress construction
and completed inventory. Analysts are claiming that the company may have capitalized $220 billion
dollars of losses as current assets. You have to wonder about the state of
other property developers in China too. Evergrande was downgraded by two credit rating
agencies last week and its Hong Kong-listed shares have collapsed by more than 80% this year.
On Monday, the Shanghai Stock Exchange paused trading in Evergrande's May 2023
bond after it fell more than 30%. What is the company doing to save itself?
On Tuesday, Evergrande issued another statement to the Hong Kong Stock Exchange,
saying it had hired financial advisers to explore "all feasible
solutions" to ease its cash crunch. The statement warned that there was no
guarantee the property firm would meet its financial obligations.
The firm blamed "ongoing negative media reports" for damaging sales
in the crucial September period," – If you can’t blame short sellers, there is always the media…
Evergrande is trying to convince its wealth management customers to accept
properties at steep discounts instead of cash repayments. Many have rejected this offer, which
required them to buy in their home provinces and was subject to approval from local authorities.
The company’s founder has appeared in social media posts showing senior executives signing guarantees
that they will complete ongoing projects. The company was working on 778 developments
in more than 200 cities across China as of the end of June.
Should the company fail in a disorderly manner, there are severe risks of contagion. Many are
asking if the government will intervene, and how might they do that. The Chinese government
will not want to be seen to bail out the company but may wish to intervene to maintain stability.
There are many financial institutions involved, the majority of which are state owned,
so the government could intervene through those channels without appearing to directly intervene.
You could see a big rescue program where the company debt gets exchanged for equity.
The company’s founder was listed by Forbes as the third wealthiest man in China last year.
He may soon be due a place on my list of billionaires who lost everything. If you haven’t
yet seen that video, here is a link. See you soon, bye.