Evergrande: To Save or Not to Save? Is China’s Financial Crisis Coming?
Hello, everyone! Welcome to “Inconvenient Truths by Jennifer Zeng”.
“To be, or not to be, that is the question” for Prince Hamlet. “To save or not to save Evergrande”, that is the question for the Chinese government, or, rather, the Chinese Communist Party, the CCP. What is Evergrande? Why is “to save or not to save” become “the question” for the CCP? Is Evergrande’s situation an indication of a looming financial crisis in China? What if the bubble bursts? Today, let’s discuss these issues.
What is Evergrande?
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Now let’s go to the real “first of all”, what is Evergrande?
China Evergrande is China's largest real estate developer by contracted sales last year. As of 2018, it was the world's most valuable real estate company. In 2019, it ranked No. 138 on the Fortune Global 500 list. Its chairman Hui Ka Yan is the 3rd richest person in China and 34th on the Forbes Billionaires 2020 list.
In the meanwhile, Evergrande is also the world’s most indebted developer.
So now you have an idea of what Evergrande is.
A Letter Pleading for Help
Several days ago, on Sep 24, there suddenly appeared on the Internet a letter from Evergrande to the government of Guangdong Province, where Evergrande is based.
In this letter, Evergrande pleaded for government support to approve a restructuring plan that has languished for four years, warning it would face a cash crunch that could lead to systemic risks.
The letter says that Evergrande has been a good guy for all these years, never creating any trouble for the government. But now it needs support from the government. If it cannot complete its restructuring on time, it will have to return 130 billion yuan, or 19 billion US dollars, to investors and pay 13.7 billion yuan, or 2 billion US dollars, in dividends, and Evergrande's debt ratio will soar to more than 90 percent, potentially causing a broken cash flow.
The letter also lists in detail all the debt Evergrande owes to a large number of banks and other financial institutions.
As of June 30 this year, the Evergrande Group has an interest-bearing liability balance of more than 835 billion yuan, or 122 billion US dollars, involving 128 banks and financial institutions.
So what does this amount of 835 billion yuan mean? Let me give you a simple idea. Evergrande’s Chairman Hui Ka Yan’s hometown is in Henan Province in China. Henan province had the 8th highest annual revenue in China in 2019, which is about 404 billion yuan, only half of Evergrande’s debt level.
In other words, the total amount of debt that Evergrande has to pay with interest is more than the total fiscal revenue of Henan province in two years combined!
To give you an idea from another angle, Turkey's total national debt is only 219 billion U.S. dollars. When Greece's financial crisis broke out, its national debt was only 378 billion U.S. dollars.
In other words, the scale of Evergrande's debt is more than half of Turkey's national debt, close to one-third of that of Greece's.
The letter goes on to say that a cash crunch of Evergrande will induce systematic financial risks, and cause cross-defaults in relevant banks, trusts, funds, other financial institutions, and the bond market.
The letter says that Evergrande has as many as 8441 upstream and downstream cooperative enterprises. So all these enterprises will be affected too.
The 4th risk listed in the letter is that employment and social stability will be affected if the government fails to save Evergrande, as it has 140,000 employees, 792 projects in 229 cities that provide jobs for 3.31 million people. If those projects cannot be finished because of a lack of funds, 2 million people who already paid for those under-construction properties will also be affected. And this in turn could cause mass protests all over the country.
Quick Denial -Analysts Not Convinced
The letter caused huge reactions both inside and outside of China. Some Chinese language media reports used such a title to describe the situation: “If you don’t save me, I’ll die and let you watch my death”. The hidden message behind it is: “If you don’t save me, watch me die and have everyone die together with me!”
On the same night, Evergrande issued a statement saying that the letter was fabricated and not true, and that Evergrande had reported this matter to the police and reserved the right to defend its lawful rights with the weapon of the law, etc.
Also on the same day, China Evergrande’s share fell 5.58%, while the share price of China Evergrande New Energy Vehicle Group fell 8.63%. By the way, Evergrande became a listed company on the Hong Kong Stock Exchange in 2009.
Although Evergrande was quick to issue a statement to deny the letter, many Chinese analysts still tend to believe it's true, for the following reasons:
The debt amount in the letter is very close to the amount on Evergrande’s financial statement for last year. Other financial data listed in the letter are very close to the true figures too. It is impossible for an outsider to fabricate such a letter.
The letter was dated August 24, just 4 days after the so-called “Three Red lines” were introduced for developers in China. The three red lines are a liability to asset ratio of more than 70%, net debt to equity ratio of over 100%, and cash to short-term debt ratio of less than 100%.
Unfortunately, Evergrande’s situation is worse than the red line level on every count, which means Evergrande will no longer be able to borrow money. So people say that’s why Evergrande wrote that letter in despair only 4 days later after the “Three Red Lines” was introduced.
3. Another fact is that Evergrande started to sell its properties at a nationwide 30% discount from Sep. In some instances, the price cut could be as deep as 42%! It shows that Evergrande is indeed in desperate need to get cash back.
Blackmailing the Government
People also say that Evergrande purposely released the letter exactly one month after it was written, because it failed to get a response from the government. Chinese people call this action “逼宮”, which literally means force the king or emperor to do something. In modern English language, we can call it blackmail or extortion.
By releasing such a letter on the Internet, Evergande was virtually threatening the government: If you don’t save me, bear the consequences!
It was said that Evergrande’s letter was very well written because it hit right at the “pain points” of the CCP.
What are the pain points of the CCP?
In the past three years, the CCP has been pushing very hard for “Six Stabilities” and “Six Safeguards”. “Six Stabilities” refer to stability in employment, finance, foreign trade, foreign and domestic investment, as well as growth expectations.
The “Six Safeguards” are safeguarding employment, basic livelihood, major market players, food and energy security, stable industrial and supply chains, and the normal functioning of local governments.
Those “Six Stabilities” and “Six Safeguards” are the things that the CCP cares about most. If problems occur in these sectors, it could mean doomsday for the CCP.
So, Evergrande must have studied these very carefully and mastered their essence very well. That’s why its threats are very real: If I die, you lose one major “market player”; if my cash flow breaks, many banks will break too, and the stability of the financial sector will be no more. Millions of people will lose their jobs or lose the money they’ve already paid to buy properties from Evergrande.
Successful Blackmail
It turns out that Evergrande’s blackmail was successful. Bondholders, banks, senior government officials, China’s cabinet and its financial stability committee, chaired by Vice Premier Liu He, etc, have all become very alarmed and held meetings to discuss the risks posed by Evergrande.
Then, yesterday, on Sep. 29, Evergrande announced that it had reached a deal with investors and that this will eliminate a looming January debt repayment deadline.
Under a 130 billion yuan ($20.39 billion) deal reached in 2017, Evergrande had issued convertible bonds with a pledge to either list its Hengda Real Estate unit on a Chinese stock market or redeem the debt. It has not been able to move forward with the listing plan.
Now, under the new deal, investors agreed to keep their shares and not require Evergrande to buy them out.
So, for now, Evergrande’s defaulting crisis seems to have passed. Its bonds and share prices have bounced back too.
An “Epic Bubble” A Gigantic Monster
The question is, why did Evergrande encounter such a crisis in the first place, forcing it to use such an extreme measure to deal with it?
Actually, Evergrande is not the only one that has encountered such a problem. The total interest-bearing debts of the top 7 developers in China have reached 2.3 trillion yuan or 337 billion US dollars. If other developers also encounter the same problem, will the government be able to save them as well?
For all these years, the competition in the real estate industry has been so fierce that every developer had to develop as fast as it could to expand its market share and to ensure its survival.
At the same time, China's economy has been moving away from the real to the virtual economy for a long time, leading to the rapid expansion of real estate enterprises. People think that speculating in stocks and properties is a fast way to make money.
As a result, China's housing prices have risen while empty homes have skyrocketed, creating an "epic bubble". According to a survey, there were more than 65 million empty homes in China in 2017.
The property speculation boom of the past few years has led to an accelerated expansion of real estate companies, which have taken out more and more loans and incurred more and more debt.
The trade war between the US and China, as well as the COVID19 pandemic, have made things worse for the real estate market, which has already become a gigantic, strange monster.
On the one hand, China’s house price to income ratio has become the second-highest in the world, and as much as 70% of residents’ wealth is locked in the real estate market. On the other hand, while many “ghost cities” were built, and many houses are empty, many people cannot afford to buy a property, or have a proper place to live.
“Too Big To Fail”?
We don’t know what all has happened during the past 5 days since the release of Evergrande’s “blackmail” letter and announcement of a new deal that can temporarily avert Evergrande’s debt crisis. We don’t know what kind of behind the scenes things happened for Evergrande’s “strategic investors” to agree to such a deal. When Bloomberg covered this issue, they call Evergrande “China’s Too-Big-to-Fail Real Estate Giant”.
However, if the No. 1 real estate giant had to resort to such an extreme means as “blackmail” to force the government to save it, how about other developers? And how about many banks and local governments that heavily rely on continuous building up of the real estate market? If the price cannot hold up any more, and if the bubble does burst-and some people do believe it will burst soon, what will happen to this “too-big-to-fail” industry, as well as to China’s financial system, economy, and even to its political stability?
I am sure many people still remember the shock waves of the global financial crisis of 2007-2008. It was triggered by the bursting of the US housing bubble and the fall of the values of securities tied to US real estate.
With the current situation in China, can the CCP handle the possible bursting of the real estate bubble? Or some other bubbles? That is also a serious question to ask.
Thank you for watching. Truth can not only save lives but also help you save money if you can learn the true situation early on. I hope you find this episode helpful. Please don’t forget to subscribe to my channel, and check out my other videos you may have missed.
Thank you. See you soon!
9/30/2020
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