The news is full of reports of the expected default of the Chinese construction company Evergrande. We decided to understand this topic and tell you about, what is happening with the company and why is it important even for those, who does not have an apartment in the PRC.
When creating the material, sources were used, which can be blocked for users from the Russian Federation. Hopefully, you know, what to do.
What is Evergrande
In its free time from financial collapses, the company acts as the second largest developer in the PRC.
From what problems
Real estate in the PRC is the main investment for most. It is approximately 75% well-being of a typical household. For comparison: real estate in the USA is about 35% well-being of the average household. All of this has led to an obscene rise in property prices and speculation in the housing sector.: since 2015, some types of real estate have risen in price by more than 80%.
And there is no end in sight to this rise in prices: Chinese stocks and bonds are not yet very interesting, they try to invest free money in real estate. This makes the Chinese people in common with the residents of the Russian Federation..
As part of the fight against rising real estate prices and speculators, the Communist Party of China began to impose restrictions in this area.: from bans on purchases to a set ceiling on resale prices.
The CCP also limited the development of the real estate market and introduced the following restrictions:
- Banks now have restrictions on issuing loans to developers.
- Highly indebted developers now have limited access to new loans.
- 22 the largest municipality party obliged to increase the sale of plots of land, while limiting the number of auctions to three.
All this led to a drop in sales and a strong decrease in the growth rate of real estate prices.. Well, sure, this led to problems for developers, whose financial situation has deteriorated: sales grew worse, than previously expected, and access to loans for operating activities was limited.
Evergrande was no exception., which has been expanding due to debt for many years. The company's dollar bonds had a very generous coupon yield - for example, 8,75% annual. As you understand, the company has accumulated a lot of debts, because she had to borrow more and more.
In the meantime, Evergrande developed in other directions as well - for example, electric cars.
Evergrande's problems were obvious to everyone for a long time.: Western observers called the company a pyramid back in 2017. So, almost a year ago, she had to pay $ 13 billion in penalties to investors, but they refused to exercise their right. maybe, helped by the connections of the company's management in high echelons.
But this did not help the company very much.: limited access to loans led to a disruption in the timing of payments to counterparties and within a year the situation reached its current state. During, by the way, company management forced employees to invest in Evergrande projects.
Recently, Evergrande paid off $ 34 million in bills from paint supplier with unfinished properties - and it became clear, that default is very likely.
Why it matters
To understand the magnitude of the problem, let's give an example from everyday life.
Imagine, what do you lend at a high interest rate to a person, playing cards. The player has been borrowing from you for several years and pays interest. At the same time, he borrows money from other people in the area at a high interest rate - and all this has been going on for many years..
Then things get worse for the player., it becomes harder for him to give money, and he starts to borrow even more. And then, if the player cannot give money and becomes bankrupt, you and other lenders will not receive money, counted on. In this case, you will begin to cut costs.: reduce dining out, start buying food cheaper and less frequently, cancel a trip to the sea, postpone buying a new car, etc.. So much for the economic crisis within the same area. If you and other lenders borrowed money yourself, counting on, that the debtor-player will return what is owed to you, then the situation will get worse for a larger circle of people: your financial difficulties will become several orders of magnitude worse, and they, who lent you money, become more prudent in lending and give less money to other people, and this will negatively affect the consumption level of these failed borrowers. Well, did you understand.
Many investors and large funds rely on coupon payments from Evergrande and ultimately redeem their bonds.. If they do not receive them, then this may affect their investment activity: she will become more conservative.
The company owes approximately $ 110 billion in bonds and loans., which is already a very large amount. But that's not all.
Considering Evergrande's debts to employees and contractors, then the total amount of debt is approximately $ 300 billion. For comparison: Greece's troubled debt, around which there was so much talk in 2012, was $ 200 billion. However, Evergrande's debt will be less than $ 600 billion in debt from Lehman Brothers, with the collapse of which the global financial crisis began.
Are they so alone or not?
Not, there are other companies from the Chinese construction sector with a lot of debt at high interest rates. The situation with them will depend on, how things will unfold with Evergrande. There are risks of major bankruptcies of a number of companies in the sector.
Will there be general consequences
We can say for sure, that within the PRC, after the whole story with Evergrande, the standards for issuing loans will begin to tighten. And that's the problem, since the Chinese corporate sector is credited for the most "I can not", even when compared with the USA. Which means, the pace of development of the Chinese economy depends on the ease of obtaining loans within the PRC.
Actually, lending rates began to decline even before, how everyone started talking about Evergrande, which led to a slowdown in the Chinese economy recorded back in August. Inside the PRC, in the event of further tightening of standards for issuing loans, money will become more difficult to borrow. The same will apply to loans outside the PRC.: investors will demand higher returns from all borrowers from the PRC due to increased risks. All this could negatively affect the plans of the Chinese corporate sector for investment and business development..
The default of Evergrande with its 1.3 thousand properties will surely lead to a serious drop in property prices., fortunately there is no shortage of supply on the market. If Evergrande goes bankrupt, then a huge volume of unfinished housing will splash into the market, and this will drop house prices even more. Considering, that many Chinese households have invested in real estate and linked their financial aspirations to speculation in it, at least a strong decrease in consumption can be expected, and as a maximum - a series of bankruptcies of individuals: I suspect, that the residents of the PRC, known for their gambling, probably took out loans secured by real estate with an eye to its sale at a high price.
By the way, sales of land for construction are 30% revenues of local municipalities in the PRC - so that the deterioration of the situation in the construction industry will affect them and affect the level of investment in the regions.
Many of Evergrande's competitors like China Resources Land, Country Garden Holdings, China Overseas Land & Investment and Longfor Group Holdings - things are getting better. But tightening credit standards within the PRC and falling property prices could lead to the bankruptcy of developers weaker, which will further drop housing prices and again affect the economy as a whole. Considering, that next year, Chinese developers will need to pay off $ 55 billion in dollar obligations, in a year we can see the collapse of dozens of "little Evergrandes".
Basically, considering all of the above, an economic crisis within the PRC is quite possible with a drop in activity in almost all sectors. Plus, Evergrande has 200,000 employees - and employs 3.8 million people every year as subcontractors.. The one-time disappearance of such a large enterprise will negatively affect the situation for everyone, who worked with Evergrande and simply depended on the demand from those, who worked for Evergrande.
Who can get hurt
Firstly, quotes of all Chinese companies may fall dramatically. Secondly, American companies with a significant share of sales in the PRC may be seriously affected, how their quotes have already suffered, if it comes to a full-blown recession in the PRC.
Thirdly, likely significant drop in commodity prices, in particular for iron ore, from investors' expectations regarding the decrease in demand in the PRC. This will make companies feel bad, engaged in the extraction of raw materials. However, here everything will depend on the duration and severity of the recession in the PRC - provided, that such a recession will still happen.
Fourth, investors may perceive the news in the PRC as a reason to arrange a large-scale sale in the United States in anticipation of a new economic crisis.
Fifth, the cost of loans for the corporate sector will increase, not only in China, but also other developing countries. The fall of Evergrande has already led to a decrease in investor interest in bonds from the PRC. Evergrande accounts for 16% Chinese corporate sector junk dollar bond debt.
If the company goes bankrupt, the default rates among Chinese junk bonds will rise from 3 to 14%. Such a leap will affect the reputation of all Chinese borrowers and make it harder for all Chinese companies to access Western capital markets.: the yield on Chinese junk bonds is now 14% per annum - much more 7,4% this February. Surely this will indirectly affect the bonds of all developing countries, including RF: in such situations, Western investors usually get rid of all non-Western assets.
Generally, nothing good will come of it - therefore you should be mentally prepared for everything.
Or maybe, everything will be ok?
It all depends on the position of the Chinese government. I doubt, that it will buy back the company's debts: it will set a bad example for all other loaned borrowers. However, The CCP doesn't want a full-blown recession either. So anything is possible.
Evergrande has assets, and with skillful management of the bankruptcy process, the consequences of default can be neutralized. But serious damage cannot be avoided.
The worst thing about Evergrande is, that the situation with the company was not a secret to anyone. Everyone knew about her problems, but continued to lend to her. How many more Evergrandes the Chinese economy is fraught with is a mystery. 99% those, who is talking about Evergrande now, found out about her just the other day. So in the future we may learn other amazing stories., like Evergrande.
I think, that such things are happening in the PRC because, that there are still many wild archaisms left. In the case of real estate, eg, technically, there is no sale of land as such in the PRC: the investor buys the right to use it - and for a certain period. That is, ownership can be extended. Or they may not extend. This significantly limits the planning horizon and stimulates thinking at the level of “grab more now, and after us even a flood ". This is basically what the Evergrande example demonstrates., who borrowed a lot of money for development and, obviously, not going to give them away.
By the way, the company's dividends were sponsored from the loans, which she has paid generously since she went public: By June 2021, Evergrande had paid RMB 69 billion in dividends to its shareholders.
Who got the most? To the head of the company and his relatives, which in total belonged at that time 76,7% Evergrande shares, - they received a total of 53 billion yuan, approximately $ 8.197 billion.
So be aware of these risks when investing in China and other ever-developing countries..