Evergrande Property Developer Update

Posted September 24, 2021

Evergrande property developer in China (3333-HK) is a situation that has been monitored since Citron Research originally wrote a research piece on the indebted property developer claiming its business model was not sustainable. Short-seller Andrew Left of Citron Research warned investors about the growing risk of Evergrande almost 10 years ago. Left was sued and barred from trading in Hong Kong markets because of his report.

In 2012, Left said that Evergrande “is insolvent” and “will be severely challenged from a liquidity perspective.” At the time, Evergrande had about $12 billion in liabilities. Roll the tape forward to September of 2021, Evergrande has more than $300 billion in liabilities and of as Thursday, September 23, 2021, is at risk of missing two of its many large debt obligations; the first payment denominated in US dollars is approximately $ 84 million. The other is 232 million yuan or about 36 million US dollars.

The situation with Evergrande is changing by the hour. Late Wednesday, September 22, 2021, the faltering Chinese real estate developer unexpectedly struck a last-minute deal to pay off part of what it owes its domestic investors, but foreign investors who are still owed millions of U.S. dollars on Thursday were out of luck.

Evergrande has not received the press like its high-flying technology counterparts in China up until now. Evergrande’s latest liquidity crisis has come as a result of the Chinese government warning the property developer that they needed to shore up their debt obligations before issuing new debt. Arguably Evergrande is one of China’s most indebted companies and is THE largest issuer of junk bonds in China. $300 billion in debt is outstanding. The problem they are experiencing right now is one of the cash flows and their bonds have now been bid down to between $.20 to $.30 on the dollar, which signals the likelihood of default is very high.

Worries about Evergrande’s ability to pay interest on its high yield bonds have prompted comparisons to the collapse of Lehman Brothers in 2008 and the subsequent financial crisis. When drawing comparisons, it is important to recognize that China’s Evergrande holds hard assets in terms of land, buildings, and other fixtures, while Lehman held financial assets.

The collapse of Lehman Brothers led to a crash in financial derivatives including credit-default swaps, collateralized debt obligations, and other complex structured financial products backed by a pool of investment-grade loans, sub-prime loans, and other assets causing the market to doubt the health of other banks. International Monetary Fund Chief Economist Gita Gopinath told Reuters this week the organization believes “China has the tools and the policy space to prevent this turning into a systemic crisis.” While there certainly is a systemic risk for the Chinese markets, the risk to the U.S. markets should be fairly limited since there are restrictions in place preventing U.S. banks from making large investments in a Chinese firm like Evergrande. As a result, access to the Chinese market for U.S. banks has largely been curtailed with larger banks recently citing that their exposure in China is limited to subsidiaries of U.S. companies.

Ultimately, the Chinese government will need to make good on properties that Evergrande has promised to deliver. Anything short of delivering on promises made to contractors and property investors will undermine confidence in the larger Chinese real estate market. Chinese real estate market collapse is something that CCP cannot afford given the massive GDP contribution real estate development has on China’s economy.

There appears to be no short-term solution. Evergrande will very likely face a U.S. Chapter 11 ‘type’ restructuring where the company can continue to operate while negotiations with lenders determine who gets what and which parts can be sold off to bring debt obligations current. Evergrande’s equity holders are in for a rough ride regardless of the outcome.

We do not have any direct exposure to Evergrande, however, we are monitoring the situation and the potential impacts it might have on our portfolios and will make necessary adjustments as new data becomes available.

Joe Maas, CIO | CFA, CFP®, ChFC, CLU®, MSFS, CVA, ABAR, CM&AA, CCIM
David Stryzewski, CEO | CSA, NSSA