Boom and Bust: The Disaster of Evergrande.

Jay Barton, The University of Warwick

Overview

Evergrande’s billionaire Chairman Xu Jiayin’s golden age which precipitated the country’s lust for urbanisation may have just been given the proverbial vote of no confidence by the markets- in fact, so much so that the Shanghai stock exchange halted trading on the renminbi-denominated 2023 bond at 49% yield due to ‘abnormal activity’.

‘Domino effect’ is not a mirage in trading markets- those close to developments in 2008 will tell you. Evergrande’s numbers has left a mark on investor confidence in China’s most risky lenders in the international bond markets. Chinese high-yield bonds were up 13.3 percent and this has a ubiquitous impact not just in the real estate sector but on the entire domestic economy. With Quantitative easing ushering the winds of change to monetary policy across the globe, this has led to an artificial lowering of company debt yield and structural shift to save those companies who on the precipice of poor economic performance, as related to the pandemic, need to raise liquidity without facing the wrath of investor markets praying for high-debt yield in a world of low interest rates to stimulate economic growth. An over-leveraged Evergrande might need intervention from the Central government to prevent defaulting- but if its past luck with the CCP is anything to go by this could be a means to an end.

Analysis

Like most listed companies, when faced with a plummeting stock it can encourage investors with two carrot-and-stick solutions- offer a ‘special dividend’ (however doesn’t have the reliability of a steady cash flow like dividend offering companies like Apple) or pursue company growth. Nonetheless, in trying to halt the sell-off and allay fears after amassing $104bn in interest-bearing liabilities outstanding in March and a 70% fall in shares in the past year as well as a local ban on apartment sales – it is merely a band aid.

The special dividend was predicated around a planned board discussion of a dividend that will centre on giving shareholders stock in Hong Kong-listed electric vehicle unit China Evergrande New Vehicle Group. If it distributes a major part of its holdings in unprofitable subsidiary Evergrande NEV, the parent company can remove 72 billion yuan in debts from its own stretched balance sheet, leading CCB International analyst Lung Siufung to say “the worst is likely over” for the property group.

Ocean Flower Island, an artificial archipelago off Hainan, was developed by Evergrande and is part of the company’s long-term commitment to expand beyond its main business of building apartments.

 ‘If Evergrande moves then it will have a pretty sizeable impact’. This would jettison any remaining confidence from investors on ‘bad’ debt issuers which hasn’t fully eased after the state bailout for China Huarong Asset management (the country’s biggest bad debt manager) which saw its leverage rise to 1,333 times at the end of last year. Evergrande’s prosperity has always been predicated on the company’s favourable relationship with the Chinese vice president Zeng Qinghong and his family in the early 2000’s but it has fallen victim to an ideological change within the Central Party. Beijing is becoming increasing aware of an asset bubble and has pressured real estate developers to cut debt and extreme wealth for those individuals who own it, are increasingly becoming alienated with President Xi promoting ‘common prosperity’.

The buck stops with Beijing- the development of Chinese private companies is based on the party’s ‘good policies’. Now the question is what this structural policy shift means for the fate of Evergrande.

Conclusion

China cannot afford to let this debt issuer fold – it must make credit readily accessible in the face of inertia from local government to issue bonds to infrastructure projects. The fate of the group has imminent importance not only within China’s financial system, but beyond it, and defaults can spread throughout the international market. Evergrande’s downgrade to a triple C credit rating and the increasing cost of borrowing could spell an end to property sector- however, this is salvageable. Though some must be wondering how.

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