Financial collapse of Evergrande - whether the domino effect of the collapse of large Chinese companies follows

The financial problems of one of the largest real estate companies in China, Evergrande, are threatening to shake the financial system there, which was also warned by the central bank. According to the media, the development of the situation in Evergrande, the second real estate developer in China with annual sales of 110 billion dollars, is attracting more and more attention from world financiers.

Evergrande Real Estate owns more than 1,300 construction projects in more than 280 cities across China. It was founded by Xu Jiayin in southern China in 1996, and is now the second largest Chinese real estate builder by sales. His jobs range from asset development to wealth management. It is also a well-known name to Chinese football fans, as it owns the largest team in the country - FC Guangzhou.

What is the cause of the problem

The boom in business, which has affected many sectors of China's growing economy, has also made Xu one of the richest members of China's business elite - according to Forbes magazine, Xu has a personal fortune of about $ 10.6 billion.

The question is why is Evergrande in trouble? In short, increasing debt and changing regulations. Evergrande’s problem came after years of unfettered expansion during which his debts grew along with size and assets. Huge debt has accumulated as loans have financed the rapid growth of the Chinese real estate market. Evergrande now operates under a debt of more than $ 300 billion, which is two percent of the value of the Chinese economy. Next year alone, $ 7.4 billion in bonds will mature, and investors are likely to write off up to 75 percent of the value of the debt.

Already these few figures show how much risk arises from the possible collapse of this company. Therefore, it is not surprising that the National Bank of China announced back in 2018 that companies like Evergrande could pose a systemic risk to the financial system there.

Evergrande is also a victim of Beijing’s changing approach to managing the Chinese economy. Shortly after coming to power in 2013, President Xi Jinping said China must "shift the focus to improving quality and restoring economic growth to real, not inflated, GDP growth."

Debt reduction has become a major part of Xi’s efforts to reduce systemic risks. It’s easier said than done, but Beijing is trying. For example, last year it introduced the so-called “three red lines” for selected companies, which severely limited their borrowing opportunities.

Theoretically, the new rules would force the entire real estate sector to reduce distribution funds to improve financial health. Some initially considered them a welcome intervention, and UBS Asset Management said earlier this year, "We have great confidence in the scope of these policies."

Evergande has announced that it is under "terrible pressure" and may not be able to meet its obligations to creditors. To raise money to repay the debts, Evergrande offered buyers a significant reduction in apartment prices, up to 25 percent, and also sold a good portion of its commercial real estate portfolio. Since the second half of last year, it has raised $ 1.8 billion by listing shares of its real estate management company.

The electric vehicle manufacturing subsidiary sold a stake to investors for $ 3.4 billion. However, investors became concerned about the situation in the company after a letter "leaked" to the public in September last year, showing that the company's management was asking the government for support for a faster listing of new shares on the stock exchange. Evergrande declared the letter false.

But the announcement from June this year, when the company admitted that it did not pay off part of its short-term debt securities on time, was not incorrect, which further intensified the concerns of investors.

This was followed by the news from July that a Chinese court froze Evergrande's $ 20 million bank deposit at the request of Guangfa Bank. In August, the National Bank and the regulator of the insurance sector announced that Evergrande must do more to reduce debt.

The company said through the Hong Kong Stock Exchange that it has hired financial advisors who will investigate "all possible solutions" to avoid financial collapse, reports the Guardian. The chaotic situation in the company is also shown by the fact that Evergrande has suspended the completion of as many as 1.5 million new apartments. As a result, some buyers of apartments on social networks started a debate on whether they would receive the money paid.

Evergrande also pressured staff to lend him money. Loans were presented as high-interest investment schemes, but those who did not participate risked losing the bonus. This month, Evergrande stopped repaying loans to employees who are now gathering on the streets in front of the company’s headquarters and demanding a refund.

Evergrande’s share price has fallen more than 80 percent this year. Credit rating agencies also downgraded his bonds.

“Evergrande’s bankruptcy will be the biggest test the Chinese financial system has faced in recent years,” Mark Williams, chief economist for Asia at Capital Economics, told Deutsche Welle.

The eventual collapse of such a giant will have consequences for the entire Chinese economy, and the potential effect of the spill is the biggest fear of the Chinese government.

Namely, the real estate sector is responsible for 29 percent of the Chinese economy. The impact on the labor market should not be neglected either. Evergrande employs 200,000 people, but hires as many as 3.8 million workers on real estate projects every year, reports Reuters.

International implications

The deterioration of geopolitical relations with the West, the coronavirus pandemic, as well as the intensified ideological campaign to determine the influence of the ruling Communist Party have already led to the fear of a constant slowdown in the world's second largest economy.

According to the Guardian, Evergrande owes money to 171 domestic banks and 121 other financial companies. Therefore, if the company does not fully fulfill its financial obligations, there will be severe consequences for the banking system. Analysts fear a credit crunch could follow, which would be bad news for China and the global economy.

UBS estimates that there are 10 companies with potentially risky positions with combined sales under a contract of 1.86 trillion yuan - or 2.7 times the size of Evergrande. In other words, the Evergrande is just the tip of the iceberg.

It is difficult to say what the international implications will be if the Evergrande collapses. Even some analysts compare this case to the collapse of Lehman Brothers as a result of the mortgage crisis more than a decade ago.

"A possible failure of Evergrande could be a significant stalemate in the real estate sector. But we don't think it's far from China's Lehman moment," Barclays analysts said in a note.

Jimmy Chang, a major investor in Rockefeller Global Family Office, believes the domino effect could spread beyond China. He told CNBC: "If China had a serious economic problem because of the Evergrande, the rest of the global economy could be infected."

Foreign owners of dollar-denominated Evergrande bonds - totaling about $ 20 billion - would not have much of an impact on what happened, so they would face a write-off, analysts say. They would probably seek their money in international courts.

Capital Economics senior global economist Simon MacAdam believes the opposite.

"On its own, a managed or even disorderly collapse of the Evergrande would have little global impact other than some market turbulence," MacAdam said in a note, CNBS reports.

"Even if it was the first of many real estate developers to fail in China, we doubt it would take the wrong step in policy to cause its economy to slow sharply."

In general, the collapse of the company is expected.

"We think it is difficult for Evergrande to meet its obligations. The execution of the project will be most important from the point of view of social stability. Therefore, buyers and suppliers of houses are most important among the participants. We think a possible scenario is that the cash flow is used only to build projects, while we expect that debt restructuring will be needed, "said Tao Wang, China's chief economist at UBS, reports the Guardian.

Anterfile: Will the government help

Beijing is facing a dilemma. If he gets involved in rescuing Evergrande, what message will it send to other heavily indebted companies? If it does not help, the consequences could spread to other sectors of the economy. In China, Evergrande is not expected to have the full support of the government.

Global Times editor Hu Xijin said Evergrande should not bet on government help on the assumption that it is "too big to fail." Policymakers in China have told major Evergrande lenders to extend interest repayments or diversion loans, but market observers are generally of the opinion that direct government assistance is unlikely.

On the other hand, a very serious potential decline of such a company led some analysts to suggest that Beijing could jump in to save it.

Mattie Bekink of the Economist Intelligence Unit told the BBC: "Instead of risking supply chain disruptions and angering homeowners, we think the government is likely to find a way to ensure the survival of Evergrande's core business.