Global markets fluctuated this week, as the debt problems of one Chinese real estate company raised fears of a new financial crisis, writes Adam Maguire.
Markets around the world were shaken this week by concerns that problems in China’s property market could turn into a crisis for the global economy.
At the center of the panic was Evergrande Group – a company that had previously been largely unknown to Irish consumers, despite being a major cog in the Chinese economy.
What is the Evergrande Group?
Evergrande Group is a large group with operations in a number of areas.
It’s involved in agriculture, renewable energy and health — and even owns amusement parks, a bottled water brand, and half of China’s most valuable soccer clubs.
However, the heart of its business is real estate, with Evergrande being ranked in recent years as the world’s largest real estate company by asset values.
Its website claims that the group currently has more than 1,300 projects in 280 Chinese cities, with more than 400 million square meters of space under its management.
Among them are the Ocean Flower Island Project in Hainan; It consists of seven artificial islands containing 58 hotels, 28 museums and an amusement park with an area of 127,000 square meters.
But amassing its portfolio came at a cost — the company currently owes investors, bondholders and others more than $305 billion.
Religion becomes theirs
This debt buildup is huge by any measure. But markets tend not to worry much about these things as long as the debtor is able to pay when the money is due.
This is the Evergrande problem. She could no longer guarantee that she would be able to do so.
A little over a week ago, the real estate company announced that She was struggling to raise money, despite his desperate attempt to sell more of the houses he was building.
At the same time, stricter regulations in China meant that the company’s ability to borrow more was severely limited.
If she cannot get cash, it becomes difficult for her to meet her debt obligations. This increases the likelihood that it will default on its loans in the near future.
A huge company default may be a problem in itself, but Evergrande’s current predicament is emblematic of the entire sector in China.
Real estate is a major part of China’s economy – recently, real estate made up 29% of China’s GDP. Much of that has been driven by companies like Evergrande that have taken on huge debts in order to finance massive construction projects.
This model may make sense when there is a strong potential for the resulting property to sell, but the Chinese market is now oversupplied.
Logan Wright, director of Hong Kong-based consultancy Rhodium Group, recently told The Financial Times that he estimated there was enough empty property in China to house 90 million people.
This is in addition to the second and third homes owned by the growing middle and upper classes in China, and despite recent videos showing many unfinished high-rise developments being demolished.
Like many companies — and countries — Evergrande’s liabilities consist of multiple loans and bonds. This means that repayment obligations fall in stages – not in one large payment.
A deadline for interest payments on two of its bonds — one domestic and one overseas — expired Thursday, the first starting point since its debt warning.
Prior to this deadline the company announced that it had “resolved” one of the payments. Details of what that means have been limited, but that doesn’t necessarily mean a payment has been made. It is also possible that Evergrande and the bond holder(s) will agree to delay payment, possibly in exchange for a higher interest rate.
However, it missed the deadline for its foreign bonds – raising fears that it was headed for a default.
With interest paid again next week, the risk is that debt problems will quickly begin to build up.
in a state of blessing
Evergrande’s payment deadlines come with a 30-day grace period — giving the company a little breathing room before it technically falls behind.
However, this grace period includes a seven-day national holiday in China, which means a long period of limited market activity in the country.
If you reach the end of the period without making the repayment, and officially default, it will send ripples in a number of directions within the Chinese economy.
Cross default provisions mean that a missed deadline for one bond could result in another bond defaulting, so that multiple Evergrande loans could default at once.
On the ground, clients who have prepaid for Evergrande properties are likely to lose little hope of seeing their homes built. Meanwhile, suppliers who have been contracted to work on their projects will not be paid.
On the financial side, as many as 171 Chinese banks and 121 financial companies are believed to owe Evergrande money to them. They will face having to write off — or write off a full — the money they put into the company.
China, all the way to New York
A relatively small percentage of Evergrande’s liabilities are held outside of China – although the company has made it clear that it will prioritize domestic investors, meaning those overseas are exposed to higher risk.
As a result, international financial firms have been queuing in recent days to reassure investors that they are not highly vulnerable to the company.
Credit Suisse says it does not hold much of the company’s debt, UBS says the risks are “non-material” while Deutsche Bank said it was not “affected” by last week’s events.
But while US and European finance companies may not be directly related to Evergrande, they are unlikely to come out completely unscathed if the company collapses.
For a start, while Evergrande may be the biggest problem in the Chinese property market right now – it’s not the only one.
There are many debt-laden companies in the market that will find it difficult to sell real estate and raise cash. The fear is that Evergrande is just the tip of the iceberg, raising the potential for more defaults, more unfinished homes and more unpaid suppliers.
A Chinese company with a high exposure to property would face its own financial pressure if it had to write off those investments.
It could create a domino effect in the Chinese financial system, and it won’t take long for it to affect investments made by companies based on this side of the world.
But even if any infection were somehow contained within China’s borders, its impact on the country would still be bad news for the rest of the world.
Falling property values, bad loans, business bankruptcies and potential homeowners losing deposits are a familiar scenario for Ireland – and it’s hard to forget what that means for the economy.
China’s importance to global GDP means that any slowdown or downturn in its economy will be felt globally.
This toxic combination would severely limit consumer spending in the country. Many US and European consumer brands — from tech companies to formula milk producers — are making a lot of money from Chinese buyers, which can do significant damage to their revenue and profits as well.
A long way from home
The CEO of Evergrande has expressed confidence that the company will emerge from its current crisis — but markets aren’t so sure.
If you can’t get people to buy houses, and you can’t borrow more, it will still be hard to get money.
It is also unlikely that someone else will be persuaded to stumble, because the size of the company makes it difficult for any white knight to save it.
Meanwhile, the current state of the Chinese real estate market will make it difficult for the company to convince investors that it will be in a position to repay its debts in the future, if they are willing to renegotiate the terms.
Instead, many believe that its only real hope for survival may come in the form of a government bailout – but so far there has been no sign of that happening.
Market watchers are not getting their hopes up either, because state intervention would go against the hard line that the Chinese leadership has taken against profit-hungry big companies in recent times. It would also create a precedent that could come back to haunt the country if all the other debt-laden real estate companies start to have their own problems.
Instead, China’s focus so far has been on maintaining liquidity in the rest of the system, with the central bank there pumping nearly $19 billion in cash into the market.
But bailout or not, it will almost certainly have to do more than that if the Evergrande story continues on its downward trajectory.
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