Is China’s Evergrande Group Financial Problem, The First Sign of Economic Crisis?

About booming Chinese Real Estate Market and Its Participants

Real Estate

The entire value of real estate transactions in China reached over 16 trillion yuan in 2019, accounting for roughly 10% of the country’s gross domestic product. The Chinese real estate industry is a significant component of the country’s economy. Real estate development has enjoyed a boom run as a result of the progressive openness of the market and the government’s stimulation of the housing industry over the past few decades.

The Chinese government and local governments control the majority of the country’s land, so the real estate market is vital to the government. Government local bodies sell the developer land rights that are valid for 99 years. As a result of this procedure, local governments earn 16-40 percent of their fiscal income from the sale of land rights.

In China, most individuals buy a home as a long-term investment, and they allocate major portion of savings in real estate. Also, a large proportion of Chinese bank loans are property related.

As per ibisworld, the sector is projected to employ almost 2.6 million people with 98,417 developers. According to the CICC, estimation roughly 399 million square meters of outdated, substandard homes will be destroyed.

The epic centre “China Evergrande Group”

Evergrande Real Estate Group Limited is a real estate development firm that was founded in 1996. The company is involved in the development and marketing of residential communities, office buildings, hotels, restaurants, and other associated properties. The Evergrande Real Estate Group sells its properties across China.

As of June 30, 2021, the Group’s total land reserves included 778 projects spread over 233 locations across China. The Group’s land reserves had a total intended GFA of 214 million square metres and an initial value of RMB456.8 billion, with a total planned GFA of 214 million square metres and an original value of RMB456.8 billion.

The Group was also involved in another 146 additional urban development projects, including 131 within the Greater Bay Area (62 within Shenzhen), 4 within Taiyuan, 2 within Shijiazhuang, 2 within Tangshan, and 7 inside other cities. (Source: Evergrande Interim Report 2021)

Chinese real estate growth: is it a bubble?

According to the draft outline of the 14th Five-Year Plan for national economic and social development and the long-range objectives through the year 2035, China aims to increase its urbanisation rate to 65 percent during the period 2021-2025. This, combined with an equally increasing GDP per capita and the long-range objectives through the year 2035, is resulting in a sustained demand for new housing. The growth of the real estate industry is supported by certain basic factors, which reduce the likelihood of a market collapse.

However, the ratio of house prices to income in some Chinese cities is so high that the housing market is creating price bubble, which is expected to collapse at some point in the near future.

Note: Ratio of median apartment price to median family disposable income, as of min-2021. Source J.P. Morgan Asset Management Guide to China

Chinese Government Control Policies to Stabilize the real estate market

The rules governing the real estate market in the People’s Republic of China (PRC) grew increasingly stringent in 2019. In order to mitigate financial risks associated with real estate, the federal government has maintained the overall policy of “No Speculation in Residential Properties” and has closely regulated capital flows in the real estate business. Meanwhile, local governments made appropriate adjustments to their control policies in response to changes in the local real estate market in order to ensure the continued implementation of the fundamental principle of “Policy by City,” fully implement the long-term management control mechanism of “Stabilising Land Prices, Housing Prices, and Market Expectations,” and promote the steady and healthy development of the real estate market.

The Chinese government announced the “three red lines” in August 2020. New guidelines for real estate company financing were created. There are three criteria used to evaluate developers who wish to refinance their loans:

  1. There should be a limit of 70% on liabilities to assets, excluding advance proceeds from projects sold on contract.
  2.  A cap of 100% on net debt to equity.
  3. There should also be a cash to short-term borrowing ratio of at least one.

Problem with highly leveraged China Evergrande Group

In mid of all the control policies, the highly leveraged China Evergrande Group is finding it difficult to raise additional debt because of “Three red lines” rules. Also, the company debt stands approx. $304 billion, as of Jun 30, 2021. That included $89 billion in debt outstanding, 42% of which was due in less than a year. The company’s borrowings include nearly $20 billion in dollar-denominated bonds.

Evergrande Stock Graph

As company is struggling to raise or refinance the debt, ~84% of the market capitalization of the company got wipe-out since January 1. Also, Evergrande has been reduced to a CC rating by Fitch, a prominent credit ratings firm, which says a default is likely.

On Sept. 23, it failed to pay $83.5 million in interest on that offshore debt, leaving foreign investors to weigh their options for recourse

Now, markets are closely watching to see if the firm will meet its $47.5 million interest payment due 6th October 2021.

Will China Evergrande Group create chain reaction?

From a market share perspective, Evergrande accounts for 16% of all outstanding high yield dollar bonds in China. The Evergrande bankruptcy may increase the country’s junk dollar default rate to 14% from 3%. In China and other bond markets, a rise in default rates may have negative consequences.

“Evergrande is such an important real estate developer, and it would be a strong signal if anything happened to it,” said Dan Wang, an economist at Hang Seng Bank. “I believe there will be some supporting measures from the central government, or even the central bank, trying to bail out Evergrande.” Source (www.cnbc.com)

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