China’s second.largest real estate entrepreneur by revenue – with commitments equal to about 2 percent of China’s gross domestic product – is in danger of collapsing. The S&P 500 fell 2% and global bond funds, some of which are significantly invested in Chinese entrepreneurs’ dollar debt, retreated. Evergrand has to pay $ 83.5 million in interest on bonds by Thursday, and it is pushing protests and lawsuits from its suppliers, customers and investors in China.
Debt insolvency in dollars or at least a deep haircut seem reasonable. Large.scale financial shocks in China are not unavoidable. If Evergrand’s troubles catch up with the rest of the property market or Beijing does not act quickly enough to create a structural change in the company’s business and its debt in an orderly fashion, the government could be in trouble similar to the real estate giant’s troubles.
In years past, such a large and important company would almost certainly have been saved. Housing is the third pillar of China’s political economy – where most of the household capital is located, it is a huge burden on Chinese banks and is linked to one – fifth of the country’s economic activity. But meanwhile President Xi Jinping is showing a much greater tolerance for economic risks than his predecessors in office, in part because he has managed to intimidate potential rivals very effectively. Evergrand’s troubles are an immediate consequence of a new and tough policy that forces entrepreneurs to meet tough debt targets, which went into effect last year.
Impact on the entire Chinese real estate market
As long as it is possible to contain the extent of the financial spread of the company’s problems within China, President Shai may allow some bondholders – especially foreign ones – to be written off in favor of larger policy objectives. Meanwhile, the signs of the spread of the problems on the continent are limited. One reason for this: Many of Evergrand’s large local debtors, such as banks, are owned by the government, which can both force them to incur immediate losses and also flood them with liquid capital while it works to find new sources of capital. Beijing has proven time and time again that it can target creditors and large debtors and force them to reach behind.the.scenes agreements, as happened in the 2019 Osheng Bank crisis.
Evergrand bonds in foreign countries are trading at very low levels, and yields on dollar.denominated bonds of several other debt.ridden construction companies, such as Sunac, have also soared. Sonak’s June 2022 bond issues, which traded at a 6% yield in early September, are now yielding a 17% yield, according to FactSet. To the domestic bond market more widely, outside the real estate sector.
The real problem is not Evergrand’s large debtors, but the small ones and the damage done to the real estate sector, which is already suffering from weakness, following a messy and expanded reorganization. This can easily be interpreted as broader problems for industry as a whole, the real economy and banks.
Evergrand has borrowed a lot of money but it also owes, as of June, about $ 180 billion to private homeowners, its contractors and others in the form of open accounts for payment and so.called contractual obligations – mostly houses not yet built, which the company owes buyers. More than half of the company’s projects across the country have been halted, according to local financial communications channel Caixin. All this is happening when house sales in China have already fallen in value in August by 20% year.on.year.
The last thing the real estate market in China and its financial system need is that apartment buyers who watch injured Evergrand customers decide as a result not to buy apartments. In order to meet new regulatory targets by mid.2023, Chinese real estate developers need to get rid of debts of 18 trillion yuan (about $ 2.78 trillion) collectively over the next two years, according to Goldman Sachs Bank calculations. Strong home sales will be necessary, but if Beijing does not act quickly to ensure that Evergrand customers get theirs, stopping the steep drop in China’s home sales rate could be a difficult task.
The easiest solution is to take over Evergrand’s standing projects by other government.sponsored developers, in exchange for the existing inventory and Evergrand’s vast land bank, plus the lubrication of additional government capital. But when the land market is already frozen – the value of deals has fallen by 90% in value in the first 12 days of September on a year.to.year basis, according to Nomura – entrepreneurs may drag their feet. If the situation continues and Evergrande has to continue to mortgage its existing properties at floor prices, it may further slow down the real estate market, given the company’s huge size. Evergrande alone was responsible for about 4% of the residential property market in 2020, according to the rating company Pitch.
The land market itself is another possible route for contagion with financial pollution, because the sale of land is such an important part of the revenues of local governments in China. Bonds of so.called local government financing vehicle (LGFV), which are used by local governments to circumvent formal budget constraints, make up a significant part of the market: about 30% of all debt within China, after government and government bonds are issued Banks, according to Wind.
Clearly, much depends on the speed with which Beijing will be able to form a coalition of entrepreneurs who will take on Evergrand’s contractual obligations or find another solution, in order to avoid a disorganized sale of its assets and a major financial blow to the company’s customers and suppliers.
If a solution is found soon and Beijing works to further ease all monetary policy, there are reasons for cautious optimism that China will still be able to avoid a significant decline and punishment in the real estate market. Prices in large markets close to the ocean still rose for the most part in August, although in many markets defined as third. and fourth.tier markets prices are starting to plummet. And the state’s inventory of assets is much lower, on average, than it was at the beginning of the major housing decline in 2015, which could have helped curb falling prices if sentiment recovers slightly: a year and a half of sales, according to ANZ Bank, against two and a half years of sales. 2015. Finally, although Chinese banks have great exposure to mortgages, unlike in the US mortgages in China are in “full refuge”, meaning that debtors must finish paying them even if they lose the home. Will fall to the floor.
A significant blow to growth in late 2021 and early 2022 now seems inevitable, but if Beijing acts resolutely it can still avoid the worst outcome. The coming weeks – usually the most vibrant period in the Chinese real estate market – will be critical.