Imagine you’re an investor or a supplier dealing with one of the world’s most valuable
property developers.
Or being one of its 200,000 employees.
Then, you find out that that very company is also the most indebted property developer
in the world, to the tune of $300 billion.
As Evergrande teeters on the edge of default, collapse would have grave consequences for
hundreds of thousands of property buyers and retail customers.
After years of borrowing to fuel its rapid growth, Chinese behemoth Evergrande is facing
a major crisis, spooking markets and prompting comparisons to the collapse of U.S. investment
bank Lehman Brothers in 2008.
So, is this China’s “Lehman brothers” moment?
Emily Tan, CNBC’s senior correspondent for our Hong Kong bureau, has been in the thick
of the action since the warning signs emerged.
Emily, you’re one of the best people I know to clue us in into what’s going on with
the Evergrande crisis.
So thanks for doing this.
It’s good to be here.
I think to understand the whole scale of it, we have to start from the beginning.
So what is Evergrande, and is it just a real estate company?
Evergrande was founded by Hui Ka Yan in 1996 in Guangzhou and basically rode China’s
property boom.
Evergrande is one of China’s largest real estate developers.
It is number two by sales.
It is listed in Hong Kong but based in Shenzhen.
It owns more than 1,300 residential projects across more than 280 cities.
And as it has made its name in residential property, it also has interests in electric
vehicles to theme parks from insurance, even to bottled water.
It also has a soccer team, Guangzhou FC, which built the world’s biggest soccer school
and has a soccer stadium under construction to go with it.
The warning signs of a potential collapse appeared as early as 2018, when Evergrande
was flagged as a risk by China’s central bank.
So how did it get to this point of incurring such a big debt?
Evergrande borrowed to finance all of its pursuits and its debt ballooned.
It has since accumulated over $300 billion in debt, giving it the title of the world’s
most indebted developer.
You can compare that with Russia’s state debt of $257 billion in 2020.
It also sold $6.5 billion in high yield management products, and that’s to an estimated 80,000 investors.
And then there’s the homebuyers that pre-paid for 1.6 million flats that have still yet
to be delivered.
I wanted to talk about China’s three red lines, right.
And it’s part of their policy to improve the financial health of the real estate sector.
Would you be able to give a brief explanation?
There are these three red lines.
The government developed this system to curb borrowing.
First, to ensure a liability to asset ratio of less than 70%.
Then, the next line, net gearing ratio of less than 100%.
And the third line, cash to short-term debt ratio of at least one.
If you cross all three of these lines, which Evergrande does, this will restrict you from
borrowing more money.
Besides being at the mercy of these policies, what else caused Evergrande to be where it is today?
A few years ago, China's most acquisitive companies were all forced to downsize following
debt-fuelled shopping sprees.
Names like Dalian Wanda, Anbang, HNA and Fosun.
Evergrande has warned investors about its cashflow issues and in September, even flagged
depressed flat sales, and it was having trouble finding buyers for all of its assets.
Evergrande recently stopped repaying investors and suppliers, halting building work at its
housing projects, and we've also heard reports now that it has stopped paying employees and suppliers.
We've seen protests, and they've showed up in their Shenzhen headquarters demanding payments
on their wealth management products
Evergrande has recently hired a debt restructuring company, Houlihan Lokey, who has advised names
like Lehman, Enron and WorldCom.
If the talk of a potential economic downturn triggered by a housing bubble sounds familiar,
it’s because it is.
13 years ago, the U.S. subprime mortgage crisis culminated with the largest bankruptcy filing
in U.S. history then, which led to the global financial crisis.
What is the domino effect of the Evergrande crisis?
We’re gonna be watching the effects on homebuyers as well as investors, because we have some
buyers paying mortgages on projects that have been suspended.
And then there are the banks, there are some 125 financial institutions, 121 non-financial
institutions with liabilities.
Then there’s the suppliers.
For example, if you look at some of these suppliers in Japan, toilet maker Toto is likely
a supplier, as China accounted for 30% of its profits in 2020.
And then there’s the air conditioning manufacturer Daikin, which gets 25% of its sales from China.
Then there are some real estate developers, and some of them are highly distressed real
estate companies, at the risk of collapse.
They are tiny, on their own, but collectively they make up 10 – 15% of the total market.
Analysts say if they do collapse, this could result in a systemic spill over to other parts
of the economy.
Then, we worry about the financial system.
Li Daokui, he’s a former advisor to the PBOC, he expects minimal spill over to the
financial system, and that’s because there aren’t derivative instruments built on the
Evergrande debt.
Derivatives are financial contracts that derive their value from the prices of other things,
such as stocks, mortgages, currencies or commodities such as a barrel of oil.
These instruments are generally used to minimize investment risks or for speculation.
So people ask, will this be a Lehman event?
Well, because there are no derivative instruments, we shouldn’t see it play out in exactly
the same way, but economic growth will take a hit.
Then there’s the shareholders, Chinese Estates.
It is the biggest shareholder behind the company’s chairman Hui Ka Yan, and they announced their
intention to sell down their entire stake in the company.
They said that the company’s directors are cautious and concerned about recent developments.
Real estate in China is estimated to account for more than a quarter of the country’s
GDP, so any fallout will result in many angry investors, doomed businesses and a very worried
government.
But, can the property market be stabilized?
So everyone’s asking whether or not there will be a government bailout, no one is really
sure.
But here are a couple of signs indicating that we may not see that.
The editor-in-chief at the Global Times, which is a publication viewed as a Communist Party
mouthpiece, declared Evergrande, quote unquote, “not too big to fail”.
And so, the company should not count on a bailout.
But then there's also policymakers that have told lenders to extend their payment deadlines
and rollover loans to Evergrande.
Some say China would be compelled to step in if the contagion was far reaching, like
if there were multiple developers.
But one company failing on its own, would be unlikely.
But wasn’t there a precedence for government bailout for debt ridden companies in China?
Yeah, we can take an example from Huarong Asset Management.
This was China's biggest bad debt manager which secured a rescue package from some of
the country's biggest financial firms.
Its plight had become the biggest test in decades of whether Beijing would shield state-owned
firms from market forces amid a renewed push by President Xi Jinping to rein in debt growth
as defaults have hit records.
So what we’re going to be watching out for is whether President Xi will balance setting
the precedent of a very expensive state organised bailout, knowing that the government can't
save all distressed developers.
And not to mention, it doesn’t really jive with his vision for common prosperity, and
an equitable society, it has no room for rescuing Hui Ka Yan, who at one point was China’s
richest man.
Emily, what is the biggest takeaway from this?
You know, it touches so many people, it's not just about an investment.
Real estate makes up more than a quarter of the Chinese economy.
This is about people's housing, they're paying mortgages for homes that have not even been
delivered yet.
People are just trying to build themselves a future.
The story continues to unfold.
Thanks everyone for watching this video,
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and while you're at it, let us know what do you think about China's real estate crisis. Stay safe.