Evergrande teeters on the edge of collapse. Will China step in to avoid a ‘Lehman moment’?

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The chant, “Give us our money!” echoed around the grand Shenzhen headquarters of Chinese property giant the Evergrande Group. Protesters packed the building’s lobby, arguing furiously with company representatives – some of whom collapsed from exhaustion – as police attempted to calm the crowd.

Evergrande, China’s second-largest property developer, is on the brink of collapse. The company has about US$300-billion in liabilities, with the first coming due this week: an US$83-million interest payment on a US$2-billion bond. Failure to pay could leave the company facing default.

Xu Jiayin, Evergrande’s billionaire chairman, has promised the company will be able to pay, writing in a note to staff that the firm “will step out from its darkest moments soon.” Few have any confidence in the prediction, however, and most investors are looking instead to the Chinese government for succour, hoping Beijing will deem the property giant too big to fail and step in to keep it afloat.

Explainer: Why Evergrande’s debt struggle is rattling investors around the world

Failure to do so, some warn, would lead to a knock-on effect that could bring down the country’s entire real estate market. Adding to investors’ stress is the fact that markets in China and Hong Kong are closed Tuesday and Wednesday for the Mid-Autumn Festival holiday.

Since China legalized private home ownership in 1998, real estate has been one of the country’s most successful sectors – with roughly 90 per cent of households owning a home – and the world’s biggest asset bubble. Chinese real estate is rife with speculation owing to easy credit and a massive oversupply. In 2018, a nationwide study found nearly 50 million apartments, about 22 per cent of the country’s total housing stock, sitting empty.

Chinese officials have tried to rein in the sector, repeatedly warning, “housing is for living in, not for speculation.” But most observers doubt the government would be willing to allow home prices – which have grown 600 per cent since 2010 and are the primary source of wealth for most families – to fall significantly.

Evergrande is emblematic of this problem. Analysts have longed warned the company was overextended, but it continued to raise money and expand into other sectors. It owns more than 1,300 real estate projects in about 280 cities, and company estimates it creates 3.8 million jobs every year. It owns stakes in everything from Guangzhou FC of the Chinese Super League to bottled water, theme parks and electric vehicles.

The debt that fuelled this expansion is coming due, however. According to Bloomberg, in addition to the US$83-million to be paid this week, Evergrande has US$669-million in payments due through the end of the year. Early next year, US$3.45-billion of the company’s outstanding bonds come due. Caixin, a leading Chinese business publication, reported Evergrande has “approached every possible buyer” to sell off some of its biggest assets, but “no deals have been reached.”

Homeowners and retail investors were among those who gathered at the company’s headquarters and offices across China last week, demanding repayment or assurances that their houses would be built. This week, the company began repaying investors in overdue investment products with discounted property, after top executives publicly signed a “military order” to complete all unfinished property developments, according to posts on Evergrande’s official WeChat account.

While an Evergrande collapse would cause immediate misery among Chinese homeowners and workers, the fear is that, as losses ripple out to the company’s lenders and bondholders, China’s entire real estate market could stumble – similar to how the collapse of Lehman Brothers sparked the slide of the U.S. housing market in 2008, sending the American economy into recession.

Investors are already feeling the pain: Chinese and Hong Kong real estate shares have plunged, and the Hang Seng Index, which lists Evergrande, fell 3 per cent Monday, while other markets around the world also saw dips as investors raced to sell off risky real estate products.

“Evergrande has the potential to be the largest corporate debt default ever, with spillovers to other financial institutions, Evergrande’s suppliers, homeowners, wealth product holders and other property companies,” said Alan Ruskin, macro strategist at Deutsche Bank. “Not surprisingly, analysts are scurrying around for touch points on where Evergrande might trigger contagion, within China and internationally.”

Beijing is not ideologically opposed to intervening to shore up markets – it has done so in the past – but regulators may fear that propping up Evergrande could send the wrong message, given that they are cracking down elsewhere on risky investments and excessive borrowing. Indeed, it was this clampdown that helped spark Evergrande’s crisis.

Regulators last year introduced “three red lines” for property developers: limits on debt-to-asset ratios, debt-to-equity ratios and cash-to-short-term-debt ratios. Evergrande has blown through at least two of these red lines, and its actual indebtedness could be even higher, analysts have warned.

But most observers agree Beijing will not stand by and allow Evergrande to become the country’s “Lehman moment,” intervening where necessary to shore up the wider economy while allowing some of those exposed, such as private banks and smaller property firms, to fail.

Analysts at the Economist Intelligence Unit said in a note: “A restructuring of debt is more likely than outright bankruptcy, given Evergrande’s sheer size, with the authorities having intervened by directing banks to allow payment extensions.

“The commitment by central authorities to prevent financial contagion will ensure a degree of state intervention, but officials will be wary of exacerbating moral hazard,” the EIU analysts said. “As a result, even if Evergrande is bailed out, some smaller developers are likely to collapse.”

Bill Bishop, a China analyst and author of the Sinocism newsletter, wrote this week that the “advantage” of the Chinese system “in dealing with messes such as Evergrande is that regulators have significant powers to ‘persuade’ other companies to help out, and a robust stability maintenance system to ensure that creditors, employees and apartment buyers will accept the best haircut on offer and not cause too much of a fuss.

“Yes there have been small protests, but if things play out as they have in other similar cases, protests will be allowed for a bit, as people need to vent, then organizers will be warned if not arrested, then the rest of the unhappy people will take what they are offered and ‘like it,’ with no recourse,” he wrote. “Equity owners and foreign creditors don’t really fit into that equation, they will likely get nothing.”

With reporting from Reuters

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