The Misery of Evergrande and the Consequential Unveiling of China’s Unstable Financial System

China’s China Evergrande Group, owing to its countless development subsidiaries, is one of the golden eggs in the basket of the Chinese financial system. A capacious channel through which flows huge amounts of capital with which the central government force-feeds the economy, the heavily indebted group is now witnessing its assets frozen by regulators and its shares slide. The big question: Will it finally fail?


Who is Evergrande?


Evergrande is China’s second largest property developer which was founded by Chairman Hui Ka Yan in 1996.


The company got listed in Hong Kong in 2009 via which it got access to the streams of capital & debt which enable it to grow its asset size to $355 billion today. It has 1,300+ developments across the country, many in lower-tier cities.


Its national sales have been seeing rather slow pace in the recent years and so Evergrande has also been branching into businesses unrelated to real estate, such as football, electric cars, insurance and bottled water.


How did concerns over debt pile arise?


Evergrande had pleaded for government support to approve a now-dropped backdoor listing plan, warning that it was facing a cash crunch. This news wasn’t supposed to come out but got leaked in September 2020 giving investors a good reason to start worrying.


In the past, the Evergrande Group has always been able to wiggle its way out of trouble. Hui’s opulent friends would prop up his bonds and stocks on his request. Fun fact: Evergrande is Asia’s largest dollar junk bond issuer. This is all due to the persistent support Hui’s friends have provided by buying up Evergrande debt.


Friends may not be enough now. At $300 billion, the liabilities facing Hui’s Evergrande are roughly equivalent to the GDP of South Africa- or that of Vietnam, Cambodia and the Maldives combined. This credit crunch is a lot more severe. With Evergrande’s dollar bond (maturing in 2025) trading at only 50 cents on the dollar recently, it is clear that the investors are already pricing in a potential default. This is not the worst. There are more problems that have shored up against Evergrande in full mood to make things worse for the company.


First, Evergrande is going to have a tough time converting apartment sales to cash. It has benefitted from a very common practice (followed by devlopers) in China called pre-sales: Consumers pay the full price of homes before they are built, handing over a lump sum and mortgage borrowing. In theory, there’s an escrow account to ring fence client money; but, in practice, they serve as a pool of funds when other channels aren’t available and hence developers have often tapped into these payments early.


However, knowing that the company is in such bad shape, many have called out at this practice. Shaoyang’s government (a fourth-tier city in Hunan province) said it had halted sales at two of Evergrande’s residential projects. Out of $45 million in Evergrande home sales made this year, only $16.37 million appeared in the designated escrow account, the city complained. Shaoyang reversed its decision only after Evergrande wired $19.77 million yuan into the account and promised the rest when banks release their mortgage loans. In a gist, Shaoyang said: Put the money where it belongs, or stop selling property.


If other cities in the country tread on Shaoyang’s path, Evergrande will have to finish its projects at a much faster pace, and deliver the keys to buyers before getting paid. This, in turn, means Evergrande will have to work harder smoothing out increasingly tense relationships with its suppliers, as well as obtaining construction loans from banks. Both will be tricky. A few prudent banks have already decided not to renew their loans to the developer. Further, Evergrande has also missed a few payments on its commercial bills, a form of short-term payables to suppliers.


Evergrande is really in a fix considering China Guangfa Bank Co., a regional bank in Guangdong province, asked a court to freeze a 132 million yuan deposit held by the developer. The dread is that trust companies and other banks will also rush to stake a claim to Evergrande’s liquid assets.


What does this mean for Xi Jinping and the Chinese economy?


No billionaire is arguably a bigger pest to the existence of President Xi Jinping's Communist Party. The sour note China Evergrande is orchestrating in world markets is raining on Xi's hit parade in Beijing.


Just recently, China's "V-shaped" return from Covid-19 was topping the charts. And the festivities surrounding the Communist Party's 100th anniversary had bought a reassured smile on Xi’s face. Now, it is turmoil in Asian money markets as investors race to mark down the value of China Evergrande's assets.


The Billionaire founder Hui seems to be running out of tycoon friends to buy his debt -- and buy him some time. Trust is waning, too, as last week even saw Bank of China's Hong Kong unit, HSBC and other household names stopped extending mortgages to buyers of China Evergrande Group's unfinished properties.


Every step Xi's party takes these days, the financial troubles self-created & suffered by China Evergrande are like some threatening soundtrack playing in the background. It hardly means China is headed toward a subprime-debt-like crisis, but it stands as a daily reminder that the veneer of Chinese stability rests on rather shaky foundations.


Article by- Ridhi Gera