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debt crisis, bond default and investor risks


The Emerald Bay residential project developed by China Evergrande in the Tuen Mun district of the New Territories in Hong Kong, China, on Friday, July 23, 2021.

Bloomberg – Getty Images China’s largest property company is at risk of collapsing, but analysts are concerned that it could have wide-reaching consequences beyond China’s borders.| Bloomberg | Getty Images

Chinese property giant Evergrande is on the brink of collapse, and analysts warn the potential fallout could have far-reaching implications that spill outside China’s borders.

Mark Williams, Capital Economics’ chief Asia economist says that Evergrande’s fall would represent the most severe test of China’s financial system in recent years.

These are the worst of its problems and what investors can expect.

How did this happen?

China’s financial systems have been put to the greatest test in recent years by Evergrande’s failure.

Mark Williams

Capital Economics, chief Asia economist

Banks have also responded to its deteriorating cash flow. Some in Hong Kong, including HSBC and Standard Chartered, have declined to extend new loans to buyers of two uncompleted Evergrande residential projects, said Reuters.

The firm’s liquidity issues have been repeatedly cited by rating agencies. Evergrande’s troubles were made worse by China’s rules that lowered the cost of borrowing for developers. These measures set a limit on the amount of debt that a company can take out in proportion to its cash flows, capital and assets.

The company’s shares plunged almost 80% this year. In the last weeks, trading on its bonds was frequently halted at Chinese stock exchanges.

Evergrande does what?

Evergrande can be found everywhere. The company’s primary business is real estate. China’s number two property developer, by sales, it is.

  • Evergrande has more than 1300 properties in more than 280 Chinese cities.
  • The company’s property management division is responsible for nearly 2800 projects in more than 310 Chinese cities.
  • There are seven companies within the company that specialize in different industries such as electric cars, healthcare services and consumer products. They also have video and television production units, and even a theme-park.
  • According to their website, the firm claims it has more than 200k employees but creates over 3.8 million indirect jobs annually.
  • Evergrande bonds and shares are part of indexes throughout Asia.

Who is affected?

There will be a wide range of parties affected, including banks, suppliers as well as home-buyers, investors and homeowners.

Evergrande warned last week that the escalating difficulties could cause wider default risks.

It said that if it can’t repay its debt, it may lead to a situation of “cross default” — where a default triggered in one situation may spread to other obligations, leading to broader contagion.

A banking failure triggered by the collapse of major property developers was the single most likely scenario that could lead to a hard landing in China.

Mark Williams

Capital Economics, chief Asia economist

Read more about China from CNBC Pro

In fact, sentiment is already spreading to Asia high yield bonds. According to TS Lombard the yields of Asian offshore bonds have risen to an average 13%. The majority are owned by property-focused firms.

According to TS Lombard, this also means that offshore investors have been losing their money.

TS Lombard said that “the company’s commitment to all pre-sold project delivery is likely will lead to offshore stakeholders not seeing very much from the eventual sale of a developers assets in case of a rescue.”

“Hence the prospect of an unequal swap, where the interests of on-shore lenders – households and banks – are protected at the expense of equity and off-shore bondholders,” the note said.

3. Suppliers

The implications of Evergrande’s failure could also reverberate through to other industries if suppliers are not paid. According to S&P Global Ratings, Evergrande might be “trying to persuade” its suppliers and contractors to accept physical properties as payment — in a bid to preserve cash for loan repayments.

Evergrande will likely be supported by the central government or the central bank.

Dan Wang

economist, Hang Seng Bank

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

Ratings agency Fitch said banks may also have indirect exposure to Evergrande’s suppliers — the developer’s trade payables stood at 667 billion Chinese yuan, according to Fitch analysis.

Are Evergrande’s assets too large to fail?

Analysts believe that Evergrande’s importance will lead to the government stepping in.

Hang Seng Bank economist Dan Wang said that Evergrande is a very important real estate developer and would send a clear signal to the government if it was ever lost. “I think there will be support measures by the central government and even the central banks trying to bail Evergrande out.”

According to some analysts, a restructuring might be more likely.

Williams, of Capital Economics stated that the most probable outcome is a managed restructuring where other developers will take over Evergrande’s remaining projects and receive a portion of Evergrande’s land bank.

According to Williams, it’s possible that banks and homebuyers will be given priority by the government over all other parties.

“Policymakers will prioritize the homes that have made deposits on properties yet to be finished. Williams said that other creditors of the company will suffer.

Natixis, an investment bank, said that the Chinese government would avoid “systemic risk” during the run-up to 2022 National Congress Chinese Communist Party. This is due to its historic importance.

The bank stated that China Evergrande’s debt crisis could also occur down the line. It added that financial loss will not be mitigated by economic growth as in the past.