Evergrande has more than 1,300 real estate projects in 280 cities and it covers 2% of the Chinese real estate market.
Evergrande is the largest real estate borrower in the world as its liabilities exceeds $ 300 billion and it has defaulted the payments. On 16 September, after a cut in credit rating, the trading of its onshore bond has been halted. As a result, China’s junk bond is offering a 14.4% yield.
The chinese Govt has not taken any step so far for the bail out. Many investor believe that Evergrande is too big to fail, however, there could be a short term impact globally on this default.
When and how the issue started
The issue began in 2020 when People’s Bank of China directed lenders to focus on ‘Three Red Lines’. This was directed in order to curb speculation in real estate activity. The Three Red Lines are a set of thresholds on three financial ratios namely Liabilities (ex-advance) to Total Assets, Net Debt to Equity and Cash to Short Term Debt. The Central bank directed that the companies that keep their ratios within the threshold would be allowed to increase the debt next year. People’s bank of china puts a maximum cap of 15% increase in debt for successive years. At the end of the June 21 quarter, Evergrande failed in meeting all of these metrics.
Also, Z-spread is increased for Evergrande. Z-spread is a measure of credit, liquidity and operational risk.
Evergrande’s Response
Evergrande communicated that it reduced debt from $110 billion (at the end of 2020) to $88 billion at the end of the June quarter. The company failed to explain about commercial bills and trade payables which are counted as liabilities on the company’s balance sheet. Evergrande liabilities have hardly reduced from December 2020, stated BondEvalue.
In June 2021, Fitch downgraded Evergrande to B from B+. Also, Moody’s also downgraded rating from B2 to B due to weak funding access.
Evergrande faced a liquidity crunch as banks and investors have avoided long-term funding to the developer.
Overall Impact
The total debt of China stands at $92 trillion and the debt to GDP ratio at the end of June quarter stood at 353%. With this ratio, any impact to real estate companies' default could put China in a challenging spot as the government has less space for fiscal maneuvering.
If this default results in economic slowdown in China, it would impact commodity exporting companies such as steel.
China holds over $1.1 trillion US bonds and treasury notes. China may choose to either sell this debt or devalue the yuan. In both the conditions, the tension between the US and China may be stretched further.
This week and the week after is very crucial for financial markets across the world as china is a global supplier and any slowdown could impact the global supply chain and overall competition. Hedging is very important against the investment made for higher returns.