Tomorrow looms as a day of crisis for beleaguered, indebted Chinese real estate developer Evergrande when interest payments on two bonds fall due.
Evergrande is prepared to pay $ 83.5 million in interest on an 8.25% five-year bond and a $ 36 million payment on other debt on the same day.
Financial markets judged the prospect of a payment to be unlikely, with one of its bonds trading below 30% of its face value. Whatever the outcome of tomorrow’s events, the prospect of default will continue to hang over the company because, depending on the Financial Time, he has $ 850 million in interest payments due before the end of the year.
On Monday, the Evergrande crisis triggered major falls in global stock markets, with Wall Street experiencing its biggest one-day drop since May. At one point, the Dow was down 972 points before cutting some of the losses to end down 614 points, down 1.8%.
The S&P 500 Index fell 1.7%, while the tech-heavy NASAQ fell 2.2% after falling more than 3% at one point during trading.
The sale was halted on Tuesday as the S&P 500 and Dow Jones fell only slightly for the day. It was largely on the backs of the insurance companies of the big financial houses that the Chinese government had the situation under control. As Bloomberg commented, “Wall Street analysts trust the Chinese Communist Party. “
He cited a list of statements that China was not facing a “Lehman moment” – a reference to the New York investment bank collapse that led to the 2008 financial crisis.
A comment from Judy Zhang of Citigroup was typical of many. “We do not see the Evergrande crisis as China’s Lehman moment, as policymakers are likely to maintain the bulk of systemic risk prevention to buy time to resolve debt risk and move the business forward. ‘marginal easing for the overall credit environment. “
But despite these assurances, the Evergrande crisis has implications for the Chinese financial system and the economy as a whole.
As the the Wall Street newspaper Columnist James Mackintosh commented, “Evergrande is China’s economy in miniature.
“Both have been operating for decades on the principle that it is worth borrowing to build, in the case of Evergrande mainly housing, in the case of China, not just apartments, but roads, tracks. railways, airports and other infrastructure. “
The Evergrande debacle was sparked by a decision last month to tighten credit regulations for highly leveraged businesses, especially in the real estate sector. She was motivated by fear that the escalation of debt, which she had previously encouraged, would get out of hand and need to be reduced lest it cause a financial crisis.
The government had sought to stop the build-up of debt for some time, largely to little effect. But the new regulations, called “three red lines”, introduced more stringent measures. The financial authorities have stated that borrowers must meet three criteria: the liability-to-asset ratio must be less than 70%; net debt-to-equity ratios had to be less than 100% and cash levels had to be at least equal to short-term debt.
Evergrande failed on all three. Its business model depended on the continuous influx of money and the expectation of continued rise in apartment prices.
She sold homes off-plan, either through a large deposit or full payment, and then used the money raised to fund other projects. The company is said to have a total of 300 billion in debt with 778 projects underway in 223 cities. It supplemented its cash flow with short-term loans, often from companies in the shadow banking system, and even raised funds from its own employees to finance day-to-day operations.
For a while it seemed to be riding a never-ending real estate boom and moved to other areas including bottled water, professional sports, and electric vehicles. He is now desperately trying to sell some of these assets in order to alleviate his cash flow crisis.
But with a credit crunch imposed by the financial authorities and a declining housing market, there is now a lack of liquidity to complete construction of many apartment building projects.
Up to 1.6 million people have invested in buying apartments that they may never receive, according to a Barclays estimate.
The crisis is not confined to Evergrande, which has been described as the “tip of the iceberg”. The credit rating of the Fantasia Group real estate development was downgraded by the rating agency Fitch earlier this month and Guangzhou R&F also saw its credit rating downgraded. Earlier this year, China Fortune Land Development, a company specializing in developing industrial parks in northern Hubei province, defaulted. It cost Ping An, China’s largest insurer, $ 3.2 billion.
Morgan Stanley estimated that real estate development companies defaulted on $ 6.2 billion in risky debt during the year through mid-August, more than the previous 12 years combined.
Evidence of the wider housing market crisis was seen this week when TV shows around the world showed videos of 15 unfinished buildings being demolished because developers ran out of money to finish them.
Despite assurances that Evergrande will not cause a financial crisis – at least in the very short term – many commentators and analysts have pointed to the effects of the Evergrande crisis on both the Chinese economy and the world economy as a whole. . It is estimated that real estate development and related industries account for more than 25% of the Chinese economy.
“It’s a threat to global growth,” said Ilya Feygin, Managing Director of WallachBeth Capital. The Wall Street Journal. “What if things got worse? It means a blow to the financial system in China [and] overall economic activity in the world due to the importance of China.
The dangers contained in the rise and rise of Evergrande have been known for some time, but it was believed that the Chinese government would ensure that they were contained. Now that assessment is at least in question.
Goldman Sachs analysts called on financial authorities to send a “clearer message” on how they intend to prevent Evergrande from causing “significant delays” to the rest of the economy. Citigroup said officials could make an “excessive tightening policy error” and Societe Generale economists said there was a 30% possibility of a “hard landing.”
Ding Shuang, Economist at Standard Chartered in Hong Kong, said: “Even though most people don’t expect Evergrande to suddenly collapse, the silence and lack of major action on the part of policy makers panic everyone.
In a note released Sunday, Goldman Sachs economists highlighted the longer-term problems with Chinese real estate development due to its key role in the economy.
“With policymakers showing no signs of easing on real estate deleveraging, the latest headlines from Evergrande suggest real estate activity could deteriorate further in the absence of the government providing a clear path to a possible resolution,” he said. they stated.
Some of the companies hardest hit by the stock market selloff triggered by Evergrande are those involved in the mining and refining of base metals. And for good reason. Quick calculations published in the FT noted that the Chinese real estate sector accounts for the consumption of about one-fifth of the world’s supply of copper and steel.
Earlier this week, Singapore iron ore futures fell 11.5% to below $ 100 a tonne. In May, the price of ore was about double that level. Last week, iron ore prices fell 20% in their worst week since the 2008 financial crisis.
This is not entirely due to the Evergrande crisis. But growing problems in China’s real estate market are fueling a broad assessment that, far from rebounding as governments abandon public health measures to deal with the pandemic, the global economy is entering a downturn.