Social unrest is Beijing's chief concern in dealing with Evergrande's debt debacle

The ruling Chinese Communist Party (CCP) appears to be proceeding with a controlled sell-off of the company's assets, leaving investors short-changed.
A commentary by Po Kong Ngan, former assistant controller at i-CABLE News
2021.10.08
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Social unrest is Beijing's chief concern in dealing with Evergrande's debt debacle A police officer talks to people that have gathered at the Evergrande headquarters building in Shenzhen, southeastern China as the Chinese property giant said it is facing “unprecedented difficulties," Sept. 15, 2021
AFP
China Evergrande’s debt crisis has sparked panic-selling on stock markets in Hong Kong and mainland China, with a domino effect on global financial markets.

The world is watching, and they want to know how the ruling Chinese Communist Party (CCP) will deal with the crisis; whether Evergrande is going to be China's Lehmann Brothers, and how much of a knock-on effect will it have on the investment environment.

The crisis has generated some unprecedented public comments from central banks.

U.S. Federal Reserve Chair Jerome Powell said on Oct. 6, after investigators contacted Wall Street firms to ask about their exposure, that the Evergrande crisis appears to be confined to China.

But he added: "You would worry it would affect global financial conditions through global confidence channels and that kind of thing," Powell said.

His comments came after Bank of Japan (BOJ) Governor Haruhiko Kuroda sought to allay those fears, saying the crisis still appeared confined to a single company. But he said the BOJ would "keep an eye" on developments.

International central banks rarely mention corporate defaults by name unless there are known systemic financial risks, so despite the reassuring tone, the fact that they have commented at all suggests a wider problem than of a simple real estate company listed in Hong Kong.

International financial media are also publishing regular articles linking Evergrande's fate to global calculations of risk.

Some clues are right there in the numbers; Evergrande’s total liabilities currently stand at 1.9 trillion yuan, which is equivalent to nearly 90 percent of Hong Kong’s GDP and about two percent of China’s total economic output.

The Economist has described Evergrande as the most indebted company in the world.

Security personnel form a human chain as they guard outside the Evergrande's headquarters, where people gathered to demand repayment of loans and financial products, in Shenzhen, Guangdong province, Sept. 13, 2021.  Credit: Reuters
Security personnel form a human chain as they guard outside the Evergrande's headquarters, where people gathered to demand repayment of loans and financial products, in Shenzhen, Guangdong province, Sept. 13, 2021. Credit: Reuters
'Insolvent by definition'
In August 2020, the central government tightened debt ratio requirements for property developers to stamp out speculation, and required them to finance projects with bank loans rather than from up-front payments from buyers.

Accordingly, they required the total debt ratio to come in at less than 70 percent, the net debt ratio to be less than 2:1 and the short-term cash debt ratio to be less than 1.

Evergrande exceeded all three restrictions, making it insolvent by definition.

It is common knowledge that Evergrande chairman Xu Jiayin's favored business model is to sell properties at a discount, and in large volumes.

Right now, Evergrande has 1,300 projects in 280 Chinese cities involving 1.4 million families.

The company has warned in a recent performance report that possible loan defaults will cause delays in payments to suppliers and contractors, which will result in the suspension of some related projects.

The impact won't just be felt by builders, suppliers, bondholders, financing banks, but by more than a million ordinary households, a factor that could lead to social unrest.

Protesters have already been gathering outside the offices of Chinese property giant Evergrande in recent weeks to demand their money back, as the company struggles to repay debts of more than U.S.$300 billion amid a liquidity crisis.

A woman cries as she and other people gather at the Evergrande headquarters in Shenzhen, southeastern China, as the Chinese property giant said it is facing "unprecedented difficulties," Sept. 16, 2021. Credit: AFP
A woman cries as she and other people gather at the Evergrande headquarters in Shenzhen, southeastern China, as the Chinese property giant said it is facing "unprecedented difficulties," Sept. 16, 2021. Credit: AFP
'Common prosperity'
Then there is the wider issue of property market regulation under CCP general secretary Xi Jinping's "common prosperity" policy, which is reshaping the entire Chinese economy, from real estate to the gig economy, online services and gaming, and education. As an economic model, it is expected to be all-pervasive.

The investment bank UBS has estimated that if there is a collapse in Chinese real estate prices, nearly 1.86 trillion yuan in pre-sale contracts could be at risk.

The ratings agency Standard & Poor's has already forecast a slowdown in real estate sales under the impact of the Evergrande crisis.

What worries analysts in particular is the potential collapse of the entire real estate industry. If Evergrande sells its assets at a low price, it may destroy the overall property market.

A downturn in the real estate market, alongside the debt exposure of real estate companies, could dramatically affect buyer confidence.

If Evergrande goes bankrupt, there will be an inevitable domino effect, leading to the failure of one highly leveraged real estate company after another, paralyzing an industry that accounts for one fourth of China's economic output.

A number of local governments in China have already issued restriction orders aimed at preventing property prices from falling too fast, suggesting that the process is already spiraling out of control.

There is also a growing fear that the Evergrande debacle could affect Chinese financial institutions, which might make it too big to fail.

Evergrande Real Estate, a subsidiary of Evergrande, has already had 132 million yuan in deposits at the Yixing branch of the China Guangfa Bank frozen by the Wuxi Intermediate People's Court.

Bank concerns
The incident has fueled concerns over the risks the Evergrande crisis poses to China's banking system, particularly a number of small and medium-sized banks with high exposure to real estate developers, including Ping An and Minsheng, for whom loans to property developers account for 10 percent of the loans on their books, far higher than the industry average of about six percent.

According to Evergrande’s letter to the government at the end of last year, its creditors include around 128 banks and 121 non-bank institutions.

The People's Bank of China has sought to reassure people that the Evergrande crisis doesn't pose a systemic risk to the banking system.

But bank loans are only one of Evergrande’s financing channels. There are also concerns about the company's use of shadow finance.

Evergrande Financial Services was set up in 2015 to sell wealth management products. It was also one of the most popular players in the peer-to-peer (P2P) banking industry at that time.

By 2019, Evergrande Financial Services had been renamed Evergrande Fortune.

According to Evergrande's Sept. 8, 2021 announcement to the Hong Kong Stock Exchange, these two subsidiaries had failed to perform their guarantee obligations for the issuance of wealth management products to third parties on schedule, to the tune of around 934 million yuan.

But Evergrande Fortune executive director Du Liang has also said it would be impossible for Evergrande to come up with the 40 billion yuan needed to redeem wealth management products all at once, suggesting that the 934 million yuan figure is just the tip of the iceberg.

According to Evergrande's annual report, 45 percent of interest payments and debt repayments it made last year were to trusts and shadow banks, far more than the 25 percent made in respect of bank loans.
'Invisible mountain of debt'
It's likely that this invisible mountain of debt is what the central government is really worried about.

It's true that, while Evergrande has debts of 1.97 trillion yuan, it also  holds total assets of 2.3 trillion yuan, including liquid cash and land reserves worth around 456.8 billion yuan.

So the key to whether it avoids bankruptcy lies with whether it will default on its bonds and bank loans; and on what proportion of its total interest-bearing liabilities.

Once a company lacks short-term liquidity, no amount of assets will help.

Reuters has suggested that there are only three options for Evergrande: an embarrassing collapse with far-reaching impact; an orderly wind-down or a bailout of China's biggest property developer by the government.

The People's Bank of China and the Banking and Insurance Regulatory Commission hauled in Evergrand executives for rare meetings in mid-August, demanding that they make every effort to maintain operational and financial market stability.

There have been rumors that an Evergrande creditor committee has been set up in Guangdong, in a bid to deal with Evergrande's debt problems in a market-oriented manner, while maintaining the operational stability of its construction projects.

The company has managed to reduce its interest-bearing liabilities by 144.7 billion yuan in the first half of 2021 by selling off assets worth more than 41 billion yuan, and bringing its net debt-to-asset ratio below 100 percent.

But the company's recent defaults on bond payments mean that it is very far from being out of the woods.

The company last month missed coupon payments on two dollar bond tranches and faces three more early next week totalling nearly U.S.$150 million.

A series of controlled demolitions may prevent a domino effect in which Evergrande takes down the whole Chinese economy.

But the biggest difference between this so-called "orderly bankruptcy" rescue operation and the Western-style, market-oriented handling of defaults is that Chinese enterprises must act in accordance with Chinese national interests first and foremost.

The so-called market-oriented treatment emphasized by the CCP is actually only a redistribution of benefits.

According to Bloomberg, while investors in Evergrande stocks and bonds will eventually receive only a small amount of their principal, Evergrande’s core business will be protected, along with the country's property market, which accounts for 28 percent of China’s GDP.

A property market collapse coupled with a soaring unemployment rate and economic slowdown would be a perfect storm that could upend social stability.

Translated and edited by Luisetta Mudie
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