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  • Imagine you're an investor or a supplier dealing with one of the world's most valuable

  • property developers.

  • Or being one of its 200,000 employees.

  • Then, you find out that that very company is also the most indebted property developer

  • in the world, to the tune of $300 billion.

  • As Evergrande teeters on the edge of default, collapse would have grave consequences for

  • hundreds of thousands of property buyers and retail customers.

  • After years of borrowing to fuel its rapid growth, Chinese behemoth Evergrande is facing

  • a major crisis, spooking markets and prompting comparisons to the collapse of U.S. investment

  • bank Lehman Brothers in 2008.

  • So, is this China's “Lehman brothersmoment?

  • Emily Tan, CNBC's senior correspondent for our Hong Kong bureau, has been in the thick

  • of the action since the warning signs emerged.

  • Emily, you're one of the best people I know to clue us in into what's going on with

  • the Evergrande crisis.

  • So thanks for doing this.

  • It's good to be here.

  • I think to understand the whole scale of it, we have to start from the beginning.

  • So what is Evergrande, and is it just a real estate company?

  • Evergrande was founded by Hui Ka Yan in 1996 in Guangzhou and basically rode China's

  • property boom.

  • Evergrande is one of China's largest real estate developers.

  • It is number two by sales.

  • It is listed in Hong Kong but based in Shenzhen.

  • It owns more than 1,300 residential projects across more than 280 cities.

  • And as it has made its name in residential property, it also has interests in electric

  • vehicles to theme parks from insurance, even to bottled water.

  • It also has a soccer team, Guangzhou FC, which built the world's biggest soccer school

  • and has a soccer stadium under construction to go with it.

  • The warning signs of a potential collapse appeared as early as 2018, when Evergrande

  • was flagged as a risk by China's central bank.

  • So how did it get to this point of incurring such a big debt?

  • Evergrande borrowed to finance all of its pursuits and its debt ballooned.

  • It has since accumulated over $300 billion in debt, giving it the title of the world's

  • most indebted developer.

  • You can compare that with Russia's state debt of $257 billion in 2020.

  • It also sold $6.5 billion in high yield management products, and that's to an estimated 80,000 investors.

  • And then there's the homebuyers that pre-paid for 1.6 million flats that have still yet

  • to be delivered.

  • I wanted to talk about China's three red lines, right.

  • And it's part of their policy to improve the financial health of the real estate sector.

  • Would you be able to give a brief explanation?

  • There are these three red lines.

  • The government developed this system to curb borrowing.

  • First, to ensure a liability to asset ratio of less than 70%.

  • Then, the next line, net gearing ratio of less than 100%.

  • And the third line, cash to short-term debt ratio of at least one.

  • If you cross all three of these lines, which Evergrande does, this will restrict you from

  • borrowing more money.

  • Besides being at the mercy of these policies, what else caused Evergrande to be where it is today?

  • A few years ago, China's most acquisitive companies were all forced to downsize following

  • debt-fuelled shopping sprees.

  • Names like Dalian Wanda, Anbang, HNA and Fosun.

  • Evergrande has warned investors about its cashflow issues and in September, even flagged

  • depressed flat sales, and it was having trouble finding buyers for all of its assets.

  • Evergrande recently stopped repaying investors and suppliers, halting building work at its

  • housing projects, and we've also heard reports now that it has stopped paying employees and suppliers.

  • We've seen protests, and they've showed up in their Shenzhen headquarters demanding payments

  • on their wealth management products

  • Evergrande has recently hired a debt restructuring company, Houlihan Lokey, who has advised names

  • like Lehman, Enron and WorldCom.

  • If the talk of a potential economic downturn triggered by a housing bubble sounds familiar,

  • it's because it is.

  • 13 years ago, the U.S. subprime mortgage crisis culminated with the largest bankruptcy filing

  • in U.S. history then, which led to the global financial crisis.

  • What is the domino effect of the Evergrande crisis?

  • We're gonna be watching the effects on homebuyers as well as investors, because we have some

  • buyers paying mortgages on projects that have been suspended.

  • And then there are the banks, there are some 125 financial institutions, 121 non-financial

  • institutions with liabilities.

  • Then there's the suppliers.

  • For example, if you look at some of these suppliers in Japan, toilet maker Toto is likely

  • a supplier, as China accounted for 30% of its profits in 2020.

  • And then there's the air conditioning manufacturer Daikin, which gets 25% of its sales from China.

  • Then there are some real estate developers, and some of them are highly distressed real

  • estate companies, at the risk of collapse.

  • They are tiny, on their own, but collectively they make up 10 – 15% of the total market.

  • Analysts say if they do collapse, this could result in a systemic spill over to other parts

  • of the economy.

  • Then, we worry about the financial system.

  • Li Daokui, he's a former advisor to the PBOC, he expects minimal spill over to the

  • financial system, and that's because there aren't derivative instruments built on the

  • Evergrande debt.

  • Derivatives are financial contracts that derive their value from the prices of other things,

  • such as stocks, mortgages, currencies or commodities such as a barrel of oil.

  • These instruments are generally used to minimize investment risks or for speculation.

  • So people ask, will this be a Lehman event?

  • Well, because there are no derivative instruments, we shouldn't see it play out in exactly

  • the same way, but economic growth will take a hit.

  • Then there's the shareholders, Chinese Estates.

  • It is the biggest shareholder behind the company's chairman Hui Ka Yan, and they announced their

  • intention to sell down their entire stake in the company.

  • They said that the company's directors are cautious and concerned about recent developments.

  • Real estate in China is estimated to account for more than a quarter of the country's

  • GDP, so any fallout will result in many angry investors, doomed businesses and a very worried

  • government.

  • But, can the property market be stabilized?

  • So everyone's asking whether or not there will be a government bailout, no one is really

  • sure.

  • But here are a couple of signs indicating that we may not see that.

  • The editor-in-chief at the Global Times, which is a publication viewed as a Communist Party

  • mouthpiece, declared Evergrande, quote unquote, “not too big to fail”.

  • And so, the company should not count on a bailout.

  • But then there's also policymakers that have told lenders to extend their payment deadlines

  • and rollover loans to Evergrande.

  • Some say China would be compelled to step in if the contagion was far reaching, like

  • if there were multiple developers.

  • But one company failing on its own, would be unlikely.

  • But wasn't there a precedence for government bailout for debt ridden companies in China?

  • Yeah, we can take an example from Huarong Asset Management.

  • This was China's biggest bad debt manager which secured a rescue package from some of

  • the country's biggest financial firms.

  • Its plight had become the biggest test in decades of whether Beijing would shield state-owned

  • firms from market forces amid a renewed push by President Xi Jinping to rein in debt growth

  • as defaults have hit records.

  • So what we're going to be watching out for is whether President Xi will balance setting

  • the precedent of a very expensive state organised bailout, knowing that the government can't

  • save all distressed developers.

  • And not to mention, it doesn't really jive with his vision for common prosperity, and

  • an equitable society, it has no room for rescuing Hui Ka Yan, who at one point was China's

  • richest man.

  • Emily, what is the biggest takeaway from this?

  • You know, it touches so many people, it's not just about an investment.

  • Real estate makes up more than a quarter of the Chinese economy.

  • This is about people's housing, they're paying mortgages for homes that have not even been

  • delivered yet.

  • People are just trying to build themselves a future.

  • The story continues to unfold.

  • Thanks everyone for watching this video,

  • don't forget to subscribe

  • and while you're at it, let us know what do you think about China's real estate crisis. Stay safe.

Imagine you're an investor or a supplier dealing with one of the world's most valuable

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Chinese property giant Evergrande has a huge debt problem – here's why you should care

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    Summer posted on 2021/09/30
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