By: Van Tran & Dylan Fox
The impact of Evergrande’s potential collapse on China’s real estate market
Founded in 1996, Evergrande is the second largest real estate developer in China. Due to its unsuccessful entrance into the EV market and China’s crackdown on the real estate sector, Evergrande’s debt has now amounted to $300 billion USD. The collapse of Evergrande will have a domino effect on China’s real estate sector and its economy, considering the sector composes a quarter of its GDP.
Highly-leveraged developers are the first to feel the impact
As the company’s offering the deepest discount ever since 2011, this leads to downward pressure on property prices throughout the nation. In addition, given the government’s reining in borrowing costs of property developers, highly leveraged developers are now at risk of going bankrupt. The latest examples of this are Fantasia and Sinic Holdings, both of which are likely to default on $206 million and $250 million of bonds respectively.
The impact on the real estate sector as a whole
Since China Chenxin Credit Rating Group has downgraded the outlook of China’s real estate sector to negative, raising capital will be significantly more difficult for all companies, thereby exacerbating the cash-strapped situation. Moreover, the Chinese government’s curb on excessive borrowings as an attempt to deflate the housing market can result in a potential supply crunch, creating a self-perpetuating cycle of downward spirals.
Evergrande’s future
With stricter regulations in place and little indication that a government bailout will take place, the future for Evergrande seems gloomy. The scale and the intricate ties of Evergrande across the real estate sector suggest that in the event of its collapse, Evergrande will take a toll on China’s real estate sector and its heavy reliance on the borrow-to-build business model.
The ramifications of Evergrande’s collapse on offshore bondholders
Evergrande’s default on their cumulative debt of approximately 305 billion US dollars has wide-ranging ramifications on a pool of investors both domestic and international. This pool is composed of both domestic and international banks, asset managers, as well as home buyers and suppliers. A significant portion of Evergrande bonds are held by offshore asset managers creating the prospect for ripples through international markets if the company is to default.
Evergrande prioritizes domestic bondholders over offshore ones
As the company sells off branches of its operations it has exclusively focussed on striking deals with Chinese creditors for its Yuan bond which comprise 70% of the debt excluding Hong Kong bondholders. North American firms are assumed to hold between 14 to 19 billion dollars worth of Evergrande’s debt which has drawn comparisons to Lehman Brothers collapse in 2008. While the firm has successfully extended or restructured parts of their domestic debt, offshore bondholders have been ignored despite the interest deadlines passing for one of their 2.03 billion USD bonds. Offshore investors have been left without payment nor communication from the cash-strapped company raising questions as to whether any funds will be recoupable from the junk bonds.
Evergrande’s inability to continue development and Property Seizure
At the heart of the issue is Evergrande’s lack of liquid funds and rising materials costs, rendering it unable to complete development of its over 200 billion dollars property holdings across mainland China that would generate revenue. This has led the company to take drastic action by compensating suppliers with other property as payment for service and materials to salvage at least some value from current projects. While domestic bondholders originally attempted to seize some of Evergrande’s property this will be far more challenging for offshore bondholders given the current political/economic landscape and tension.