EXPLANATION: the fight against the debt of Chinese manufacturers shakes investors
BEIJING (AP) – Global investors anxiously watch as one of China’s largest real estate developers struggle to avoid defaulting on tens of billions of dollars in debt, fueling fears of possible wider shockwaves for the system financial.
Chinese regulators have yet to say what they might do with the Evergrande group. Economists expect Beijing to step in if Evergrande and lenders fail to agree on how to handle its debts. But any formal resolution is expected to result in losses for banks and bondholders.
Government “does not want to be seen as engineering a bailout” but is likely to organize debt restructuring to “reduce systemic risk and contain economic disruption,” said Tommy Wu of Oxford Economics in a report.
Evergrande is the biggest casualty to date of the ruling Communist Party’s efforts to curb soaring debt levels that Beijing sees as a possible threat to the economy.
Investors are watching how the developer, headquartered in the southern city of Shenzhen, near Hong Kong, handles an interest payment due Thursday on one of its bonds.
A look at Evergrande and her anxiety about her debt problems:
– WHAT IS EVERGRANDE?
Evergrande Group, founded in 1996, is one of the largest Chinese manufacturers of apartments, office towers and shopping centers and one of its largest private sector conglomerates.
The company says it has more than 200,000 employees and supports 3.8 million jobs in construction and other industries. Evergrande claims to have 1,300 projects in 280 cities and assets worth 2,300 billion yuan ($ 350 billion).
Evergrande founder Xu Jiayin was China’s richest entrepreneur in 2017 with a net worth of $ 43 billion, according to the Hurun Report, which tracks China’s rich. He tumbled down the list as internet industries boomed, but still ranked as China’s richest real estate developer last year. He also topped Hurun’s list of philanthropists in 2020, donating around 2.8 billion yuan ($ 420 million).
Evergrande has diversified into electric vehicles, theme park development, health clinics, mineral water and other businesses.
– WHAT IS THE IMPACT SO FAR?
Evergrande shares traded in Hong Kong have fallen 85% since early 2021. Its bonds are trading at an equally steep discount.
Xu built Evergrande on borrowed money, perhaps even more than his rivals in an industry that relies on debt. As of June 30, Evergrande reported 2,000 billion yuan ($ 310 billion) in past due debt owed to bondholders, banks, construction contractors and other creditors.
Of this debt, 240 billion yuan ($ 37.3 billion) was due in one year, down 28.5% from the end of 2020, but nearly triple the 86.8 billion yuan (13.5 billion dollars) of Evergrande’s cash, according to a company financial report.
In early 2021, Evergrande predicted that its total annual transaction volume would exceed 2,000 billion yuan ($ 310 billion). It said first-half profit of $ 1.4 billion, but says sales are weakening because news of its cash shortage makes potential buyers nervous.
Evergrande has been caught off guard by new limits placed by regulators on real estate-related borrowing as part of the Communist Party’s marathon campaign to reduce reliance on debt.
Economists warn that China’s growing debt has been a potential threat for more than a decade. The ruling party has made reducing these financial risks a priority since 2018. But total corporate, government and household borrowing reached nearly 300% of economic output last year, up from 270% in 2018. This is unusually high for a middle income country.
News reports indicate that Evergrande borrowed wherever it could, including demanding employees of its construction contractors to buy back its debt.
In 2017, state-owned China Citic Bank in Shenzhen agreed to lend 40 billion yuan ($ 6.2 billion) for an Evergrande project only after its executives agreed to invest at least 3 million yuan (465 000 dollars) each, according to the economic news magazine Caixin.
– HOW DOES THIS FIT INTO THE PARTY’S PLANS TO REMOVE THE CHINESE ECONOMY?
The Communist Party has cracked down on debt as it tries to foster self-sustaining economic growth based on domestic consumption rather than trade and debt-backed investment.
This enabled the first default on Chinese corporate debt since the 1949 revolution in 2014, as part of efforts to force borrowers and lenders to be more disciplined. Until then, the government had intervened to bail out insolvent borrowers to avoid scaring financial markets. Beijing has gradually allowed more defaults, but none by such a large debtor as Evergrande.
– AND THE OTHER REAL ESTATE DEVELOPERS?
Other large developers such as Vanke Co., state-owned Poly Group, and Wanda Group have not reported similar issues. But hundreds of small developers have shut down since regulators in 2017 began tightening control over fundraising tactics such as selling apartments before construction begins.
However, Chinese residential real estate is considered low risk to the financial system, as most apartments are paid for in cash and not with mortgages. This makes a wave of defaults like those in the United States after the 2008 crisis unlikely and more manageable for banks.
“Considering the hypertrophy of Chinese real estate developers, there could be a whole wave of defaults around the corner,” but Beijing has the resources “to prevent a full-blown Chinese credit crunch,” said Simon MacAdam of Capital Economics in a report. “For all its flaws, it is one of the advantages of having a tightly controlled financial system over a more liberal system.”
âRISK OUTSIDE OF CHINA?
Some commentators suggest Evergrande could become China’s ‘Lehman moment’, referring to the failure of Wall Street bank Lehman Brothers, a precursor to the 2008 crisis. But economists say the risk of a Wider contagion of financial markets is low.
âA managed default or even a messy collapse of Evergrande would have little global impact beyond some market turmoil,â said MacAdam of Capital Economics.
Evergrande has $ 18 billion in foreign currency bonds outstanding, but much of it is held by Chinese banks and other institutions. Unlike Lehman, whose assets were financial instruments whose prices can fluctuate wildly, Evergrande has 1.4 trillion yuan ($ 215 billion) of land and partially completed projects with relatively stable prices.
In the unlikely event of outright default, China’s banking system has an annual profit of 1.9 trillion yuan and reserves of 5.4 trillion yuan against bad debts, “which could easily absorb the loss.” Macquarie Group Larry Hu and Xinyu Ji said in a statement. report.
– WHAT’S NEXT?
Investors are waiting to see what Chinese regulators might do, but analysts say they appear to be focusing on protecting homebuyers by ensuring apartments already paid for are completed.
The government has pumped money into other insolvent Chinese companies, but economists say Beijing seems determined to avoid doing this with Evergrande.
In August, Huarong Asset Management Co., Ltd., the largest of a group of companies formed to help resolve bad debts held by state-owned banks, was bailed out with a capital injection of companies from State after losing 102.9 billion yuan ($ 15.9 billion) last year.
In a letter to employees on Tuesday, Xu expressed confidence that the company would survive.
âEvergrande will surely emerge from the darkest moment as soon as possible,â Xu said in the letter marking the traditional Mid-Autumn Festival.