China has discovered the concept of “too big to fail” with the Evergrande disaster:
As of the end of June, Evergrande had nearly 2 trillion yuan ($309 billion) of debts on its books, plus an unknown amount of off-books debt. The property giant is on the verge of a dramatic debt restructuring or even bankruptcy, many institutions believe.
A bankruptcy would amount to a financial tsunami, or as some analysts put it, “China’s Lehman Brothers.” The venerable American investment bank’s 2008 collapse helped trigger a global financial crisis.
Evergrande, one of China’s three biggest developers, has a giant footprint in China. Its liabilities are equivalent to about 2% of China’s GDP. It has more than 200,000 employees, who themselves and many of their families have invested billions of yuan in the company’s WMPs. The company has more than 800 projects under construction, more than half of them halted due to its cash crunch. There are thousands of upstream and downstream companies that rely on Evergrande for business, creating more than 3.8 million jobs every year.
Like many of China’s “too big to fail” conglomerates, Evergrande’s crisis has fueled speculation over whether the government will step in for a rescue. Several state-owned enterprises, including Shenzhen Talents Housing Group Co. Ltd. and Shenzhen Investment Ltd., both controlled by the Shenzhen State-owned Assets Supervision and Administration Commission (SASAC), are in talks with Evergrande on its Shenzhen projects, according to people close to the talks. But so far, no deals have been reached.
A potential default by Evergrande could spread to markets outside China as it has huge, high-interest offshore bonds. Some of its offshore bonds carry interest rates as high as 15%, a person close to the Hong Kong capital market said. UBS estimates that $19 billion of Evergrande’s liabilities are made up of outstanding offshore bonds.
Evergrande has been frantically selling properties at discounts this year. In late May, it offered certain homebuyers 30% to 40% off if they paid entirely in cash. In the first half, the company reported 356 billion yuan of contracted sales, slightly higher than 349 billion yuan for the same period last year. Average selling prices in the first six months declined 11.2%. Meanwhile, payables increased 14.7% to 951 billion yuan, and sales and marketing expenses increased 30% to 17.8 billion yuan. In response to the market environment, the company increased sales commissions and marketing expenses, the company said.
Compared with its competitors, Evergrande has higher capital and human costs but lower selling prices, an industry participant said. “How can it make money?” the person said.
The developer reported a 29% slide in profit for the first half. Its 10.5 billion yuan of profit mainly reflected an 18.5 billion yuan gain from the sale of some shares and marked-to-market holding in internet unit Henten Networks. It reported a loss in its core property business of 4 billion yuan.
Evergrande’s extremely high debt ratio, high financing cost and repeated delays in payments to suppliers, partners and local government show that its liquidity has always been tight, but on the other hand, the fact that it has survived years under this model indicates that it has always been able to generate money, a veteran investor said.
Now everyone is watching whether it can dodge the bullet once again.
I would not assume that the Chinese government will follow the lead of the US government and bail out Evergrande and the banks whose failure it threatens. First, Xi Jinping hates corruption with a passion and he is not likely to care one little bit about saving the wealth and careers of all the bankers and businessmen at risk. Second, China has seen how the 2008 financial crisis weakened the USA, and how the US failing to burn the dead wood in the financial sector had terrible consequences for its real economy.
We know the Chinese were paying very close attention to the 2008 situation and its aftermath, because the strategic guideline of Tao Guang Yang Hui established under the Deng regime was officially revised for the first time after the global financial crisis, which the Chinese interpreted as marking the end of the USA as the singular superpower.
So my guess is that unlike the US government, the Chinese government will protect the common people at the expense of the financial sector.