China's Evergrande Crisis: Real Estate Sector Sinking in Debt

Harshit Verma Harshit Verma
Sep 23, 2021 11 min read
China's Evergrande Crisis: Real Estate Sector Sinking in Debt

A crisis is any event or period that will lead, or may lead, to an unstable and dangerous situation affecting an individual, group, or all of society. Crises are negative changes in human or environmental affairs, especially when they occur abruptly, with little or no warning. - Wikipedia

Ever since the inception of human life on the planet earth, or even before that time, We have faced Crisis. So much so that it is a part of life and we don’t deface the fact anymore. Crisis has taught us that we lack something, and we need to work more on the present systems to make things more liveable. Making us more decisive, it cures indecision. This is a kind of help in our constant journey of making things better. However, We humans are the dominant species in nature.

Why, you may ask ? Because we have hacked evolution !

Ours is the only species that has decided to actually become better or more efficient without waiting for the process of evolution to take place (that is always slow). So, we are the only animal who has hacked evolution. That makes us the most fast-paced living species than anyone. Does that mean we don’t have a crisis anymore? No, we get crises every now and then to showcase us that some things are just so fickle. A house of cards.

We all are terrestrial mammals, we live on earth, land. Build houses and earn a living. Housing or real estate is a super demanded domain in this world. As population boosts we will want more and more houses, dwellings to accommodate people. Amongst the constantly rising demands for land, it is very imperative for all of us to make sure that land is distributed justifiably. To provide for the need that is round-the-clock. Not to mention, being such a big sector, Housing sector or real estate sector is not oblivious to shockwaves, you know CRISIS. Whenever a wave hits this epicentre, human lives move. It moves to that extent of magnitude which we cannot even measure on a Richter scale.

China is the world’s most populous country on the globe. Most humans live there. Housing sector is as big as it gets. It has seen its share of crises in this magnanimous sector. A really big economy. It has seen his share of strides and waves of uncertainties on his pupils. Lets see an example for clarity.

The Real Estate Bubble (2005-2011) in China
EverGrande Crisis in China
The Lehman Brothers Financial Crisis
EverGrande’s Cash Crunch
Decline in Contract Sales
Evergrande Crisis Consequences
Evergrande Crisis Effect on India

China's Evergrande Crisis

The Real Estate Bubble (2005-2011) in China

Real estate in China is developed and managed by public, private, and state-owned red chip enterprises. In the years leading up to the 2008 financial crisis, the real estate sector in China was growing so rapidly that the government implemented a series of policies—including raising the required down payment for some property purchases, and five 2007 interest rate increases- due to concerns of overheating. But after the crisis hit, these policies were quickly eliminated, and in some cases tightened.

The Chinese property bubble (2005-2011) was a real estate bubble in residential and/or commercial real estate in China. The phenomenon has seen average housing prices in the country triple from 2005 to 2009. It deflated in 2013.

Massive doesn’t even begin to describe the situation with China’s property market, but that’s somewhat expected with a population of 1.4 billion people.

And as the chart below shows, the bubble keeps on getting bigger!

China Real Estate Bubble
China Real Estate Bubble

Well we know that this thing is of the past. This was a crisis and China hopefully learned some things from it. That's why storms come, to make us more stable. This article is not about the past but for the future. This point in time, we are gonna see another crisis. Maybe more tense than the past. Maybe a more lethal Than past. So, what is it this time ?

EverGrande Crisis in China

China’s second biggest real estate mogul EverGrande is facing a crisis. To be more precise the company is going through financial difficulties. It is having liquidity issues to pay back its lenders. To give you some context, China's real estate market has been booming in the recent past and to capture the trend and grow, Evergrande had taken up so much debt that they are struggling to pay it off now. The magnitude of this upcoming crisis is such that, if it collapses, people will lose homes. Not only China’s economy but the global economy as a whole could be affected. Lets see what is the scene here,

The Evergrande Group or the Evergrande Real Estate Group (previously Hengda Group) is the second largest property developer in China by sales, having developed projects in over 170 cities in China. It is ranked 122nd on the Fortune Global 500. It was founded in 1996 by Xu Jiayin. It sells apartments mostly to upper and middle-income dwellers. In 2018, it became the most valuable real estate company in the world. Evergrande Group owns 565 million square metres of development land and real estate projects in 22 cities, including Guangzhou. The company and Alibaba own 50 percent each in Guangzhou Football Club and Evergrande football school is the biggest football school in the world. In the year 2009, the company filed for an IPO, An Initial Public Offering to get public

As of September 2021, the company is at risk of defaulting on its debt. An estimated 1,500,000 customers could lose deposits on Evergrande homes that have yet to be built.

“I think ultimately the Chinese authorities will step in to make sure at least the wider financial system doesn’t run into a crisis,”. “If you’re a property developer you’re facing a few bleak months ahead. The key distinction I think is policymakers will allow property developers to suffer considerable pain, but they’ll step in to make sure the banking system is okay.” - Mark Williams, chief Asia economist at Capital Economics.

Kotak tweeted, the threat over China's second-largest real estate developer reminded him of Infrastructure Leasing & Financial Services (IL&FS). Last year in September, the infra leasing and financial services company wasn't able to pay its debt due to shortage of funds. The financial services market felt the tremors, and led to a liquidity crisis. However, the government came to its rescue and hand-picked nominees to replace the board in October. It had extended Kotak's term as non-executive chairman of the debt-ridden group by one year.

Lauding the government's swift decision-making, the 62-year-old veteran banker said the Indian leaders provided calm to financial markets. "The government-appointed board estimates 61% recovery at IL&FS. Evergrande bonds in China trading, approximately 25 cents to a dollar," he wrote.

The Lehman Brothers Financial Crisis

Lehman Brothers Holdings Inc. was a global financial services firm founded in 1847. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill), with about 25,000 employees worldwide. It was doing business in investment banking, equity and fixed-income sales and trading (especially U.S. Treasury securities), research, investment management, private equity, and private banking. Lehman was operational for 158 years from its founding in 1850 until 2008.

The bankruptcy of Lehman Brothers on September 15, 2008 was the climax of the subprime mortgage crisis. After the financial services firm was notified of a pending credit downgrade due to its heavy position in subprime mortgages, the Federal Reserve summoned several banks to negotiate financing for its reorganisation. These discussions failed, and Lehman filed a Chapter 11 petition that remains the largest bankruptcy filing in U.S. history, involving more than US$600 billion in assets.

The bankruptcy triggered a 4.5% one-day drop in the Dow Jones Industrial Average, then the largest decline since the September 11, 2001 attacks. It singled out a limit to the government's ability to manage the crisis and prompted a general financial panic. Money market mutual funds, a key source of credit, saw mass withdrawal demands to avoid losses, and the interbank lending market tightened, threatening banks with imminent failure. The government and the Federal Reserve system responded with several emergency measures to contain the panic.

Radhika Gupta (MD and CEO of Edelweiss) said in a public notice that the real estate sector is highly regulated, given the large role it plays in the Chinese economy. In synopsis, the fund managers(at Edelweiss) do not think that the sector is facing systematic risk(Risk inherent to the entire market). The government is prioritising this issue and rapid regulations are expected. She also advised that investors with a long term horizon should stay patient as fund managers at Edelweiss see a transitory volatility.

Tweeted as a part of a disclaimer, the Edelweiss Greater China Equity Offshore Fund was at its highest risk on the Riskometer.

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EverGrande’s Cash Crunch

Dear Shareholders, I am pleased to present the reports of China Evergrande Group (“Evergrande” or the “Company”) and its subsidiaries (the “Group”) for the year ended 31 December 2020. The Group’s turnover and gross profit for the year amounted to RMB507.2 billion and RMB122.6 billion respectively. Net profit was RMB31.4 billion. Core business profit was RMB30.13 billion. In order to repay the trust and support of shareholders, the Board recommended the payment of a final dividend of RMB0.152 per share for the year 2020, which will be distributed upon approval at the general meeting of the group. - Prof Hui Ka Yan (Chairman of the Board of the Group, Chairman of the real estate group)

This is quoted from the annual report of 2020 of the company. It paid a dividend. The company was saying it out loud and clearly, that we are fine, Everything is fine, we are paying dividends, Take your profits share, shareholders. Well now we see the whole big picture, Loud and clear.

Evergrande founder and Chairman Hui Ka Yan continued his precipitous drop in Bloomberg’s wealth ranking as the company’s shares fell to their lowest in a decade. His fortune now stands at $7.3 billion, down from a peak of $42 billion in 2017.

Smothered by a $300 billion liabilities burden that has crushed its credit rating, share prices and reputation among a once-adoring public. Throughout last week, the concourse outside Evergrande's mirrored offices in the southeastern city of Shenzhen was occupied by unpaid contractors, angry sales agents and investors scenes echoed across a country where prolonged protest is rarely tolerated.

Now, as default appears all but inevitable, fears are abounding of a contagion within the Chinese property market -- and far beyond.

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Decline in Contract Sales

The month of September is typically when real estate companies in China record higher contract sales of properties. However, the ongoing negative media reports concerning the Group have dampened the confidence of potential property purchasers in the Group. The Company expects a significant continuing decline in contract sales in September, thereby resulting in the continuous deterioration of cash collection by the Group which would in turn place tremendous pressure on the Group’s cash flow and liquidity.

Here is a little excerpt of previous financial statement to back the downward trend in operations of the company.

Balance Sheet Excerpt of last year.

As disclosed in the Operating Statistics Announcements, the contract sales of properties of the Group in each of June, July and August 2021 amounted to RMB71.63 billion, RMB43.78 billion and RMB38.08 billion, respectively, which showed a decreasing trend.

Announcements and Notices by Evergrande (14 September,2021)
The Real estate giant also mentioned in a recent public open notice that -

  • No material progress on sales of interests in members of the Group
  • The disposal of the Company’s office building in Hong Kong has not been completed within the expected timetable

The Problems:

  • The company has $300 Billion debt to bondholders
  • Property sales declining for months and will continue
  • Company owes $103 billion to construction companies and other business creditors
  • Banks are not ready to refinance
  • Company wants to repay debt in the form of property and parking spaces
  • China's Government has imposed limits on the amount of real estate borrowings, which caused bondholders to withdraw their money
  • EverGrande now needs to pay interest of $83.5 Million on bonds now, with a grace period of 30 days

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Evergrande Crisis Consequences

  • China stock markets and Global markets, mainly in the US is reacting negatively to the news.
  • Stock markets globally sank on Monday as investors weighed the risk of a spillover from Evergrande’s debt. Bitcoin dropped 5.4 percent this week to $45,025
  • China's property market is majorly affected and we see the 2008 financial crisis all over again.
  • Evergrande bondholders might sell their other investments too to keep their money as cash at the moment. This might cause market correction
  • In an effort to flatten the crisis curve, China’s central bank boosted its gross injection of short-term cash into the financial system after concern over a debt crisis at China Evergrande Group roiled global markets. The People’s Bank of China pumped 120 billion yuan ($18.6 billion) into the banking system through reverse repurchase agreements, resulting in a net injection of 90 billion yuan.
Injecting funds to flatten curve.
  • China bails out the company indirectly by asking borrowers(state owned banks mainly) to take the property and parking spaces and waive off the debt.

Evergrande Crisis Effect on India

  • Sensex and Nifty are at great heights and thus are more volatile to corrections.
  • Short term corrections may happen
  • Over a medium term, India can benefit from the situation because the Chinese crisis cause increased money flow into the Indian markets
  • This crisis can put the rupee under pressure. If Evergrande is allowed to default, the market could see a massive sell-off with significant contagion risks for global financial markets - HDFC bank economist’s report.
  • If one single company that owes $304 billion can develop financial exposure to hundreds of lenders, millions of investors in bonds and stocks, and hundreds of thousands of homebuyers, Then we cannot be sure of big corporations anymore in china.
  • Indian steel still sees a strong spine as evergrande goes to a cash crunch.
Improvement In indian steel sector
  • Shailendra Kumar, Chief Investment Officer at Narnolia Financial Advisors feels till now Evergrande issue looks localised and Chinese policymakers should be able to handle it using steps like restructuring. He believes the Indian economy and Indian equity market is set for exciting times ahead. "While the global trend of digitalization is a megatrend favouring the Indian economy, domestically, formalization is another megatrend adding further positivity to Indian equities," he said.

So, what shall happen tomorrow, for sure we can't predict it to a nice accuracy, But we can surely see that what we are facing is risk, Uncertainty or maybe the silence before a storm. Let's call it a crisis.


What is Evergrande crisis?

Evergrande is an enormous company embedded across China's financial system and economy, that relies mainly on real estate.

What does Evergrande do?

Evergrande Group is an investment holding company in China. It is involved in real estate business. Evergrande group does development, investment, and management of real estate properties.

Who is the founder of Evergrande Group?

Xu Jiayin (Hui Ka Yan) has founded Evergrande Group, headquartered at Shenzhen, Guangdong, in 1996.

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