China Evergrande Group (HKSE:03333, Financial) has had a rough 2021 thus far. Down 45% since the start of the year, China’s largest property developer is now trading on bankruptcy fears.
Evergrande has seen its fortunes fade precipitously in recent weeks as long-standing fears about its extreme leverage and debt balance have come to fruition. Having struggled for years under an unsustainable -- and ever-growing -- debt burden, the company’s balance sheet appears at last to have been stretched to the breaking point.
Historic credit losses loom
The sheer scale of Evergrande’s bad debt is remarkable in itself, as "The Last Bear Standing," a financial blog, observed on July 20:
“It has US$107b of ‘debt’ on B/S as of 12/31 with half due this year. But this dramatically understates its obligations. Add $80bn of commercial paper (some may overlap with the B/S debt). Add $90bn of stretched A/P. Add construction capex for presold [apartments]. Add off B/S debt...No one really knows how much Evergrande truly owes but it is unfathomably large - hundreds of billions of USD. Its cost of debt was high before this crisis - short term USD bonds were issued at 8-11%. Its cost of debt now does not exist as it cannot borrow in size.”
All told, Evergrande’s debts are likely in excess of $300 billion. After several close calls in recent months, investors and state institutions alike seem to have lost faith the company’s ability to make good on its obligations, as Bloomberg discussed on July 19:
“Long-simmering doubts about Evergrande’s financial health intensified this week after the developer had a $20 million bank deposit frozen by a local court and was hit with a sales ban by a city government alleging it failed to set aside enough funds in escrow accounts. The city later removed the ban, providing some relief for Evergrande’s stock, but investors remain worried the company isn’t selling properties and other assets fast enough.”
Things have only gotten worse over the past few days, thanks in no small part to the growing number of Evergrande’s lenders and counterparties who are no longer willing to give it the benefit of the doubt. As Bloomberg reported on July 21, Evergrande’s list of allies has become rather thin and a growing number of creditors and suppliers have begun to circle the wounded property developer.
Symptom of a systemic problem
Evergrande has skirted the edge of insolvency before, but the situation has never looked bleaker than it does now. Evergrande may have trouble wringing out a financial rescue package from a government that has shown even more reticence toward bailouts in recent months. As Bloomberg noted earlier this week, this new stance could prove problematic for the severely leveraged property developer:
“While Evergrande has emerged from past liquidity crises intact, some investors are betting this time will be different as Chinese President Xi Jinping’s government becomes more tolerant of defaults. Several large state-owned banks have already reduced their lending to Evergrande...The risk is that a major payment failure at Evergrande ripples through China’s financial system, eroding confidence in other highly leveraged property companies, shadow lenders and even some banks.”
With Evergrande teetering ever nearer to the brink of insolvency, a number of analysts and observers have begun to consider the broader ramifications of such a large corporate collapse. Yet, the collapse of Evergrande could end up triggering a sector-wide rout. If the company goes under, it could drag China's highly leveraged and extremely bubbly property market down with it. Fear of potential contagion alone could roil the country's credit markets.
Global contagion risk looms
Should Evergrande end up imploding in anything like the spectacular fashion that some analysts fear, the financial fallout would almost certainly extend far beyond China’s borders. As hedge fund manager Brad Munchen warned on July 21, the damage could even spread to the United States:
“The big question is how much of a contagion the implosion of China's real estate bubble will be on the US financial sector. Evergrande...is teetering on bankruptcy and its bonds are yielding >30%. This will be a test of how strong the Chinese credit markets are.”
Thus far, few international investors have been willing to sound the warning bell about the deep-rooted issues facing China’s credit markets. Indeed, despite the monumental scale of Evergrande’s problems, it is still largely being viewed as an odd duck rather than a canary in the coal mine. Faith in China’s ability to keep its domestic property market bubbling remains strong. Yet that international confidence may be misplaced, as analysts warned this week.
While a disorderly collapse could undoubtedly cause widespread financial damage, it seems unlikely that the central government would demur from intervening in the event of financial contagion. While the Xi regime may be willing to allow one developer to collapse, it surely has little interest in seeing its entire property market collapse with it.
