debt crisis, bond default and investor risks

Chinese real estate giant Evergrande is on the brink of collapse, and analysts warn that the potential fallout could have far-reaching implications that extend beyond China’s borders.

“The collapse of Evergrande would be the biggest test the Chinese financial system has faced in years,” said Mark Williams, chief economist for Asia at Capital Economics.

Here’s just how serious his problems are and what’s in store for investors.

After years of rapid expansion and recovering assets while China’s economy was booming, Evergrande is now under crushing $ 300 billion in debt.

The world’s most indebted real estate developer has struggled to pay off its suppliers and has twice warned investors in as many weeks that it could default on its debts.

On Tuesday, Evergrande said its real estate sales would likely continue to drop significantly in September after falling for months, making his cash flow situation even more dire.

The Chinese developer is so huge that the fallout from a potential default could not only hurt the Chinese economy, but spread to markets beyond.

Banks have also reacted to the deterioration of its cash flow. Some in Hong Kong, including HSBC and Standard Chartered, have refused to grant new loans to buyers of two unfinished Evergrande residential projects, Reuters said.

The rating agencies have repeatedly downgraded the rating of the company, citing its liquidity problems. Evergrande’s problems escalated last year when China introduced rules to control developer borrowing costs. These measures cap debt relative to a company’s cash flows, assets and capital levels.

Its share price has plunged nearly 80% so far this year, and trading in its bonds has been repeatedly halted by Chinese stock exchanges in recent weeks.

Evergrande is everywhere. Its main activity is real estate and it is the second largest real estate developer in China in terms of sales.

• Evergrande has more than 1,300 real estate projects in more than 280 cities in China.
• Its property services management arm is involved in nearly 2,800 projects in more than 310 cities in China.
• The company has seven units operating across a wide range of industries, including electric vehicles, healthcare, consumer products, video and television production units, and even a theme park.
• The company claims to have 200,000 employees, but indirectly creates more than 3.8 million jobs each year, according to its website.
• Evergrande stocks and bonds are included in indices across Asia.

The stakeholder group includes banks, suppliers, home buyers and investors.

Evergrande warned this week that escalating problems could lead to broader default risks.

He said that if he can’t repay his debt, it can lead to a “cross-default” situation – where a default triggered in one situation can spread to other bonds, leading to wider contagion.

1. Banks

The banking sector would be among the first to be affected if there were any spillover effects on the wider real estate sector in China, said Williams of Capital Economics.

“A bank failure triggered by the collapse of major real estate developers was the most likely scenario that could lead to a hard landing in China. And the fact that financial markets are not currently sounding the alarm doesn’t mean they are not. won’t, ”Williams wrote in a note last week.

2. Buyers and investors

Protests by angry buyers and investors have erupted in recent days in some cities, and social unrest is among the concerns.

Monday, a hundred investors presented themselves at Evergrande’s headquarters in Shenzhen, demanding repayment of loans on overdue financial products – forming chaotic scenes, according to Reuters.

In fact, sentiment is already spreading to Asian high yield bonds. Yields on Asian offshore bonds, dominated by real estate companies, climbed 13% on average, according to TS Lombard.

It also means foreign investors lose out, the research firm said in a note last week.

“The company’s guarantee to deliver all pre-sold projects is likely to result in overseas stakeholders seeing little or nothing of the final sale of a developer’s assets in the event of a bailout,” TS said. Lombard.

“Hence the prospect of an unequal exchange, where the interests of on-shore lenders – households and banks – are protected to the detriment of holders of off-shore shares and bonds,” the note said.

3. Suppliers

The implications of Evergrande’s failure could spill over to other industries as well if suppliers are not paid. According to S&P Global Ratings, Evergrande may “try to persuade” its suppliers and contractors to accept physical properties as payment – in an effort to preserve liquidity for loan repayments.

In an August report, S&P estimated that over the next 12 months, Evergrande will have more than 240 billion yuan ($ 37.16 billion) in bills and contractors’ trade debts to settle – about 100 billion. yuan of this amount are due this year.

An Evergrande paint supplier, Shanghai-listed Skshu Paint, said in a filing that the real estate company has paid off some of its debt in the properties – and unfinished ones.

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

The government is likely to intervene due to the importance of Evergrande, analysts say.

“Evergrande is such an important real estate developer, and it would be a strong signal if anything happened to him,” said Dan Wang, economist at Hang Seng Bank. “I think there will be backing measures from the central government, if not the central bank, to try to bail out Evergrande.”

But a restructuring might be more likely, other analysts say.

“The most likely final phase now is a managed restructuring in which other developers take over unfinished projects from Evergrande in exchange for a share of its land reserve,” Williams of Capital Economics said in a note last week.

The government is likely to prioritize homebuyers and banks over other parties, he said.

“The top priority for policymakers would be households that have handed in deposits for properties that have not yet been completed. The company’s other creditors would suffer,” Williams wrote.

Investment bank Natixis said the Chinese government would avoid “systemic risks” in the run-up to the 2022 Communist Party of China National Congress, given its historical significance.

“However, it would also imply that the China Evergrande debt crisis could snowball down the road,” the bank said in a note, adding that economic growth would not mitigate financial losses as it was. case in the past.