China Evergrande: Subprime on steroids, or crisis averted?
When China Guangfa Bank Co successfully applied to freeze $20 million in assets associated with China Evergrande in a court in China’s Jiangsu province in July 2021, few predicted that it would mark the start of one of the most consequential financial events in China’s modern history.
$20 million is just a drop in the ocean for one of the world’s biggest property developers. However, for months concern had been mounting about Evergrande’s spiralling debts.
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The China Guangfa Bank Co matter (involving money owed by an Evergrande subsidiary) was resolved just days later. But since, Evergrande’s astronomical debt burden has continued to unravel, prompting fear the ripple effects could spread globally. Some have even suggested it could be the catalyst for another subprime-style crisis.
Who is China Evergrande?
China Evergrande cranes dominate the skylines of many Chinese cities. The company develops and manages real estate across China, primarily focussing on residential apartment complexes. According to the company website, Evergrande Real Estate owns more than 1300 projects in over 280 Chinese cities.
It is the second-largest property developer in China and up until 2022 ranked amongst the top 150 companies in the world based on revenue. According to Fortune 500, the company had over 123,000 employees, and posted total revenues of $73.5 billion in 2020.
Alongside its enormous property development and management operations, Evergrande has also made investments into other sectors such as electric vehicles, internet and healthcare businesses.
The company was founded by billionaire businessman Xu Jiayin in 1996. He is ranked by Forbes as the third-richest person in China and the 31st richest man in the world.
Xu Jiayin, 62, announced his resignation as Chairman of Evergrande Real Estate Group on Tuesday, August 17, 2021.
Just months later, Xu Jiayin, reportedly sold personal shares, villas, mansions and private jets to inject cash into China Evergrande has the company’s debt crisis intensified.
Evergrande is listed on the Hong Kong stock exchange (HKG: 3333). For much of 2022, its shares have been in a trading halt, pending a long-awaited restructuring plan.
China Evergrande’s debt crisis
There’s speculation of more than $356 billion of global debt exposure to China Evergrande.
The company is the largest issuer of US dollar denominated Chinese junk bonds – bonds that very few investors now want to touch.
As Hilliard MacBeth, author of When the Bubble Bursts, put it on the Richardson Wealth blog, in August 2021:
“Evergrande bonds which had been trading at par, and maturing in 2025, are now trading below 40 cents.
“This implies a return of more than 2.5 times in just 4 years, plus a 10.5 percent coupon, which means that the market believes there is little chance that Evergrande can pay this debt.”
In 2022 things have got a lot worse. The yield to maturity on Evergrande bonds maturing in 2023 is now hovering at around 117% as all Evergrande U.S. dollar denominated bods slide to distressed levels.
Rapid debt-fuelled expansion is widely attributed as the main reason China Evergrande finds itself is a such a perilous position today.
“They did it (growth) in such crazy mass, with lots and lots of debt,” explained macro strategist Tyler Neville on the On The Margin podcast.
Timeline: The unravelling of China Evergrande
Key developments in 2021
Since the China Guangfa Bank Co court proceedings were made public in July 2021, the company debt crisis has rapidly unravelled, spooking global investors and causing major economic and social problems problems within China.
Just days later in July 2021, an avalanche of law suits were initiated by Evergrande’s suppliers for unpaid bills. These early suitors included Huaibei Mining Holdings Co, which took court action over an alleged unpaid bill of $84 million, an unnamed investment company that won a court order to freeze Evergrande’s 20% stake in Shanghai-listed Langfang Development Co, and advertising company, Leo Group, which claimed it was owed around $61.5 million.
Further, Chinese local government authorities also revealed they were in negations with Evergrande over money owned for land.
The extend of the debt problems has, not surprising, prompted ratings agencies to take action.
On Thursday, August 5, S&P downgraded the company’s credit rating from B- to CCC (two levels), while also lowering the long-term rating on U.S. dollar notes issued by Evergrande from CCC+ to CC-.
“Evergrande’s liquidity position is eroding more quickly and by more than we previously expected,” said S&P.
“The company’s non-payment risk is escalating, not only for the substantial public bond maturities in 2022, but also for its bank and trust loans and other debt liabilities over the next 12 months.”
Other major ratings agencies, including Moodys and Fitch, also posted similar credit ratings downgrades.
Late in 2021, a run of missed bond coupon payments all but confirmed what many were beginning to fear – Evergrande was broke.
These missed offshore bond payments were covered extensively by Asia Markets in the following articles:
- Evergrande bankruptcy cover-up claims as more debt deadlines loom
- Evergrande bond payments again sugar-coated by anonymous sources, but bankruptcy could come in “matter of days”
The missed bond payments had ripple effects across major global financial institutions such as Blackrock, Ashmore Group, Allianz, HSBC and UBS, who were Evergrande bondholders and were reportedly forced to write-off billions.
Key developments in 2022
Fast-forward to 2022 and all the major ratings agencies have either withdrawn ratings on Evergrande and its subsidiaries or downgraded them to ‘default’ after the company failed to make multiple coupon and maturity payments on various offshore bonds.
In China, however, the impacts on Evergrande suppliers and middle-class Chinese property investors were beginning to hit hard.
Domestic suppliers and creditors owned hundreds of millions by Evergrande began to walk away from the company, convinced they would never see the money owed.
Most apartments sold by China Evergrande were sold on a pre-sale model – meaning buyers paid deposits upfront and began paying mortgage repayments, before the buildings were even under construction. This has led to rare public protests in China as buyers of Evergrande apartments who paid for apartments realised they may never see them.
Subsequently, it emerged in mid-2022 that hundreds of apartment buyers within dozens of stalled Evergrande construction projects had united to boycott mortgage repayments for incomplete apartments they purchased.
While investors have long debated the presence of a Chinese property bubble, bubble speculators may feel vindicated.
While it’s in Beijing’s best interest to try mitigate a catastrophe, the administration has stopped well short of indicating a bail-out may be on the table – this a continuation of a more cautious policy approach to debt that’s been a trademark of the China Government in recent years.
On Thursday August 19, 2022, The People’s Bank of China and China Banking and Insurance Regulatory Commission took the unusual step of publicly urging Evergrande to take action to reduce its debt risk. It followed a meeting with company executives.
“Evergrande, as a top real estate company, must earnestly implement strategic arrangements made by the central government to ensure the stable and healthy development of the real estate market, and strive to keep operations stable,” the public statement read.
The statement went on to urge Evergrande to “actively diffuse debt risk and maintain real estate and financial markets stability.”
24 hours later, Evergrande management responded saying it would “fully implement” Beijing’s requirements, including reducing its debt risks and maintaining market stability.
The main – and seeming only – only tool being used by Evergrande to reduce its debt burden has been asset sales – most of which have involved Chinese state-owned enterprises.
The most notable asset sales over the past two years have included:
- September 2021: Sale of Evergrande’s 19.93 percent stake in the Shengjing Bank for close to $1.6 billion.
- November 2021:Government takeover over Evergrande’s Guangzhou Evergrande Football Stadium (settling liabilities in the hundreds of millions).
- November 2021: Sale of shares in the company’s Electric Vehicle subsidiary to fund ongoing manufacturing operations.
- November 2021: Sale of Evergrande’s 18 percent stake in internet services platform HangTen Networks for around $290 million.
- November 2021: Sale of company private jets, raising $50 million.
- February 2022: Sale of Evergrande’s 10 percent stake in the Evergrande Daishan Garden residential project in Chongqing, and a 9.87 percent stake in the Dongguan Evergrande Yuelong Terrace project in Guangdong, raising $290 million (and settling liabilities of over $1 billion)
- March 2022: Sale of Evergrande’s Crystal City construction project in Hangzhou for $575 million.
The asset sales, along with a series of debt deadline extensions have created some renewed hope that Evergrande can recover and in mind 2022 the company seemed keen to publicise progress at it construction sites, as reported in this Asia Markets article.
But experts have pointed out the scale of the debt runs deep, and much more will need to be done to avoid what many fear is the greatest threat to global markets.
China’s Lehman Brothers?
The collapse of world’s most indebted property developer could have an enormous impact on global investment markets.
David Llewellyn-Smith, co-author of The Great Crash of 2008 (currently a strategist at renowned Australian Investment Manager, Nucleus Wealth), is watching the devolvements closely and believes the significance of what’s occurring should not be lost on investors.
“Evergrande was once China’s greatest property developer. It is now an unbelievably over-leveraged tottering edifice with fewer and fewer friends and a near-impossible equity value below 10% of its debt load,” he wrote in Australian publication, Livewire.
Llewellyn-Smith also highlights something many industry insiders have long suspected – that the stable coin Tether is exposed to Evergrande’s commercial paper.
“This $300 billion debt monster is potentially China’s Lehmann Brothers, trading in subterranean junk debt to Chinese (and global) counterparties (which may include Bitcoin via Tether) at spreads that imply insolvency. There is no realistic scenario for restructuring Evergrande in which market dislocation is avoided. It is only about how much pain the Chinese government can bear.
“And there is a conga-line of Evergrandes queuing up in the property sector.”
Tyler Neville made a similar comparison noting: “If they’re borrowing money from the commercial paper market and doing all these funky things then this is sub-prime on steroids.”
“There’s probably a lot of other exposure… you could be looking upwards of a trillion or a couple trillion dollars.
Hilliard MacBeth further points out the baking sector “contagion” that could emerge.
“So far, Evergrande’s financial problems have not impacted other large developers or the Chinese banks. The largest Chinese developer, Country Gardens, is still trading near its all-time high,” he says.
“But aggressive price cuts on home pre-sales by Evergrande pushed home prices back to 2016 levels. Land costs have risen substantially, so profit margins are eroding. This could impact all developers, as buyers wait for price reductions before buying.
“The largest banks in the world are Chinese, with six of the top 11… The exposure of Chinese banks to Chinese real estate developers is enormous. About half of the assets (loans) held by the top ten banks are in China, about $15 trillion.”
Chinese Government stimulus
While a direct Evergrande bail-out by the Chinese Government is off the table, in 2022, the Government has announced major stimulus packages to support the country’s beleaguered property sector.
In August, it was announced $29.3 billion in “special loans” would be made available to property developers to ensure troubled housing projects can be completed and apartments delivered to buyers.
This followed major infrastructure stimulus announcements by the Chinese Government weeks earlier, totalling $160 million.
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Extra Reading: 18 facts about China Evergrande
China Evergrande has been making headlines over the past two years for all the wrong reasons.
In mid-2021, the world began to learn the real estate giant was in such dire financial trouble it was posing a threat to global markets. Today, and Evergrande is still failing to repay debts and there are warnings the company is at risk of a brutal collapse. Major creditors have parted ways with the developer amid fears about its immediate future.
Here, we give you the 18 facts you need to know about China Evergrande as its fate hangs in the balance.
1. China Evergrande was once the world’s most valuable real estate company
In 2018, before its debt crisis, Evergrande had become the most valuable real estate company on the planet.
The company’s financial report for that year contained the following impressive numbers (in US dollars):
- Revenue: $69.7 billion
- Net income: $5.6 billion
- Assets: $281 billion
- Equity: $46 billion
2. China Evergrande has existed for almost three decades
When was China Evergrande founded?
Evergrande group was established in 1996 by Hui Ka Yan (Xu Jiayin in Mandarin Chinese) in the city of Guangzhou. It was previously known as the Hengda group.
3. China Evergrande owned 565 million square meters of real estate
At one point, the amount of development land owned by China Evergrande added up to 565 million square metres. These properties were spread across 22 cities, including:
It is not known how much of that land has been given up by Evergrande since its major financial problems began.
4. China Evergrande owns a football club
Which football club does Evergrande own?
Evergrande purchased the Guangzhou Football Club in 2010. Immediately, the company set about spending big on top-level players and in 2013 the team won the AFC Champions league.
Who else owns Guangzhou Football Club?
At the time of publication, China Evergrande owns 56.71% of Guangzhou Football Club. The other owners include Alibaba Group (37.81%).
5. China Evergrande’s founder was once Asia’s richest person
Hui Ka Yan (or Xu Jiayin Mandarin Chinese) had a net worth of $45.3 billion in 2017, before Evergrande’s debt crisis took a signficant toll.
In 2021, Xu sold mansions and private jets to cover the some of the company’s debts and at the end of that year his net worth had fallen to $6.2 billion. That makes him the 462nd richest man in the world.
Xu is said to have come from humble beginnings. He was raised by his paternal grandmother after his mother died when he was only eight years old and after school he started working in a cement product factory.
6. China Evergrande owns an electric vehicle company
Which electric vehicle company does Evergrande own?
China Evergrande owns the China Evergrande New Energy Vehicle Group, which was established on August 28, 2019. The company was founded by Xu Jiayin and is headquartered in both China and Sweden.
7. China Evergrande once hired Jackie Chan
In 2013, Evergrande paid world famous actor and stuntman Jackie Chan to promote a high-end mineral called ‘Evergrande Spring’, which it claimed was extracted from the natural springs of China’s Changbai Mountains.
Chan was brought on as an official brand ambassador and Evergrande had plans to list the company on the stock market.
Eventually, however, it emerged the water originated from the same source as cheaper spring water brands, and interest in the product tanked. Evergrande decided to ditch the brand and Jackie Chan was no longer required!
Some put this down to the ‘Jackie Chan’ curse, pointing to other examples of company’s failing shortly after Jackie Chan was used for promotion.
8. China Evergrande donated to Harvard Medical School early in the Covid-19 pandemic
In February of 2020, China Evergrande pledged to donate $115 million to Harvard Medical School.
The deal raised some eyebrows and in 2022 the payment would become the focus of a probe into whether the origins of COVID-19 were covered up by top United States officials.
United States Senator Marco Rubio sent a letter to the President of Harvard University, Dr. Lawrence Bacow, which demanded more information about the agreement. He demanded to know whether Evergrande, which has close ties to the Chinese Communist Party, was trying to buy access to influential American scientists, including Dr Anthony Fauci, the head of the National Institute of Allergy and Infectious Diseases.
9. A rumour linked China Evergrande to the China Eastern Airlines crash
In 2022, there were reports that the co-pilot of China Eastern Airlines flight MU5737 crashed the aircraft in a murder-suicide having lost his life-savings in the Evergrande debt crisis.
One media outlet examined claims that the pilot, Zhang Zhengping, left a suicide note accusing the leaders of China Eastern of “squeezing” employees and the Chinese Government of creating a “bubble” in the economy.
The claims also suggested Zhengping invested in Evergrande and all of his savings went to zero when the company began encountering serious debt troubles.
10. China Evergrande owns Ocean Flower Island
Evergrande group owns Ocean Flower Island, which in 2021 was opened as the world’s largest artificial island.
In 2022, however, as Evergrande’s debt problems intensified it was revealed that local authorities had demanded 39 of the island’s towers be demolished because environmental and zoning regulations were ignored over 10 years of development.
11. China Evergrande has a health arm
The China Evergrande group purchased New Media Group Holdings in March 2015 and renamed it Evergrande Health, which operates “Evergrande Health Valley” in the Chinese city of Nanning.
The company also built Boao Evergrande International Hospital (BEIH), which it says “provides world-class cancer care with its unique patient-oriented health management system.”
12. Cryptocurrency stablecoin Tether reportedly owned China Evergrande’s commercial paper
In 2021, David Llewellyn-Smith, co-author of The Great Crash of 2008 (currently a strategist at renowned Australian Investment Manager, Nucleus Wealth), claimed that the cryptocurrency stablecoin ‘Tether’ was exposed to Evergrande’s commercial paper.
“This $300 billion debt monster is potentially China’s Lehmann Brothers, trading in subterranean junk debt to Chinese (and global) counterparties (which may include Bitcoin via Tether) at spreads that imply insolvency,” Llewellyn- Smith said.
This claim has since been denied by those behind Tether.
13. Evergrande’s debt has reached hundreds of billions of dollars
In December 2021, ratings agency Fitch Ratings downgraded China Evergrande, amid reports its liabilities had reached $300 billion.
Meanwhile, around the same time, S&P Ratings said Evergrande was “highly likely to default” early in 2022.
“At some point … Evergrande’s massive debt will catch up with it,” the S&P report said.
“The firm has lost the capacity to sell new homes, which means its main business model is effectively defunct.
“This makes full repayment of its debts unlikely.”
14. China Evergrande raised $722 million in its IPO
Thirteen years after it was founded, China Evergrande held an Initial Public Offering on the Stock Exchange of Hong Kong, which raised US$722 million.
During its debt crisis in 2021, shares in Evergrande Group fell below the Initial Public Offering price of HK$3.50.
15. China Evergrande is incorporated in the Cayman Islands
While China Evergrande is headquartered in the in the Nanshan District, Shenzhen, Guangdong Province, it is incorporated in the Cayman Islands, a British overseas territory.
16. An allegation of criminal misconduct was filed against China Evergrande
In February of 2022, an allegation of criminal conduct was filed against the directors of China Evergrande.
Credit analyst Dr Marco Metzler accused the company of insolvency fraud in documents submitted to the Director of Public Prosecutions in the Cayman Islands.
“The company defaulted in December … but the directors did not file for bankruptcy in the Caymans, where the group his headquartered,” Dr Metzler said.
“(Therefore) they are in breach of their duties (and this is) a crime in the Caymans. We have reported this to the public prosecutor to start an investigation.”
17. China Evergrande is not currently China’s largest developer
China Evergrande was China’s largest developer by sales, until it was surpassed by Country Garden in 2017.
Country Garden, which is also incorporated in the Cayman Islands, was responsible for more than 200 high-end township developments throughout China, Australia and Malaysia as of 2018.
18. China Evergrande has many US-based investors
The fate of China Evergrande is important to the United States because many Americans have exposure to the company in their retirement accounts, college funds and pensions.
Who are the US investors in Evergrande?
In September of 2021, US Senator Marco Rubio suggested BlackRock, UBS, HSBC and Ashmore Group are among Evergrande’s US-based investors. This is also backed up by Bloomberg data, which you can see in this Asia Markets article.