THE POTENTIAL COLLAPSE of arguably China’s largest property development company, Evergrande Real Estate Group, has cast a pall over global markets in recent days.
That panic crystallised in a stock market sell-off earlier this week with Hong Kong’s Hang Seng index closing down 3% on Monday while the S&P 500 suffered its biggest drop since May.
Cooler heads are beginning to prevail, however, after the company gave some indication that it will be able to make interest payments due on its debts.
But far more important than the gyrations of markets are the concerns that the developer’s implosion could potentially tank the Chinese financial system and economy with serious ramifications for the rest of the world.
After all, cash-strapped Evergrande has borrowings of $300 billion (€245.8 billion) — or around 2% of China’s Gross Domestic Product — making it more than likely the most indebted company in the world.
Let’s look at the details.
What, exactly, is Evergrande Group?
A more accurate question would be, ‘what isn’t Evergrande?’
It’s a behemoth, basically, that does just about everything.
While its stock in trade is certainly property development, the group owns a diverse portfolio of assets in the Chinese energy and healthcare sectors as well as a mineral water brand.
This is far from an exhaustive list — the group even owns a majority stake in a football team, Guangzhou FC, currently managed by World Cup-winning Italy captain Fabio Cannavaro.
Certainly, though, real estate is the group’s bread and butter.
Evergrande owns a reported 1,300 property assets across 280 cities while its property services division is involved in the management of over 2,000 projects.
Why is Evergrande in the news?
The reason the company is making headlines this week is that it’s due to make interest payments on two bonds — one worth about $84 million (€71 million) and the other, $35.9 million (€30.6 million).
Earlier this week, it looked to be unable to make either payment.
Its debts are now junk-rated, meaning they carry a high risk that the company won’t be able to pay them.
A default on its obligations this week could see other creditors call in Evergrande’s debts, which could signal the company’s death knell.
Should this happen, the concern would be that financial institutions — particularly Chinese ones from which the company has borrowed heavily — could be left badly exposed.
A particularly chaotic collapse could, in theory, blow a hole in the Chinese economy, an appalling vista for the world economy as it emerges from the pandemic.
Worryingly for those of us who even vaguely remember it, the ghosts of the Lehman Brothers collapse in 2008 have also been invoked in recent days.
So massive was the US bank’s borrowings and so spectacular was its fall that it triggered a situation where many other banks and institutions no longer trusted each other enough to lend to one another.
This ‘credit freeze’ helped to create the conditions for the global financial crisis.
Hasn’t the issue been resolved?
No, not really — but there has been some good news in the past 24 hours, which you may have seen some headlines about this morning.
One of Evergrande’s property divisions filed a document with the stock exchange in Shenzhen, announcing that it had reached an agreement with bondholders over the $35.9 million payment due.
The filing was silent on the question of the larger, $84 million debt, however, which is also due tomorrow.
But if it misses the payment, the company would still have a 30-day grace period before it is deemed in default.
Even if its creditors tried to have Evergrande wound up in court, it would have six months to prepare a restructuring plan under Chinese law, the Financial Times reported this week. That deadline can also be extended by a further three months.
What’s likely to happen?
Well, the consensus is that in some capacity, the Chinese government will step in.
This could take the form of a full-on bailout, which could prove extremely costly and dent economic progress, much like our own bank bailouts did to the Irish economy.
A rescue package of this variety isn’t inevitable, however, unless Evergrande’s collapse looked likely to take other property companies with it.
“We believe Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy”, credit analysts at S&P opined earlier this week.
In other words, to oversimplify it massively, Evergrande isn’t ‘too big to fail’.
Given the level of control that the Chinese government has over the country’s financial system — it owns the four biggest banks in the country, which are also the four biggest banks in the world in terms of assets — other options are available.
The government could use its so-called ‘bad banks’ — similar to our own Nama — to absorb some of Evergrande’s borrowings.
A forced restructuring of the company’s debts could also be on the cards. Evergrande might also be broken up, its less important assets sold off and its more central, revenue-generating operations retained.
It’s worth noting that the Chinese government has been trying to take the sting out of the country’s heavily indebted private property sector by actively forcing it to deleverage, a bid to reduce the domestic financial system’s exposure to a potential crash.
Foreign investors are concerned that pressing ahead with this campaign could further damage the sector.
That remains more of a bigger picture issue at the moment, however. The most immediate question is whether and how the Chinese government will step in to stanch the bleeding.
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