The Evergrande Crisis - The big real estate company in china is melting Down.

 

Chinese debt has grown rapidly since 1990's and up until the mid 2000's this debt funded necessary and productive investments, which meant that the return on these investments grew faster than the debt did.

Real estate and real estate valuations are usually found at the root of all debt. Most loans are made against hard assets (like:- real estate), which can be repossessed.

Now let's understand, How property market works in china? 

➨Property is never "Owned" in china, it is leased from the government for a set amount of time most commonly 70 years and these land leases are then purchased by property developers like Evergrande. 

➨The property developers will then design apartment buildings and Pre-sale the units they designed to regular investors, who will put down a deposit and wait for the buildings to actually be finished.

➨The developer can then take this money and use it as a down payment to borrow even more money to either buy up more land leases, or to use on the actual construction of buildings on that land.

➨The banks and non-banking lenders were able to give money to an institution that was offering good returns on a secured line of credit.

➨Most of these lenders figured that in the extremely unlikely scenario that if a company (like:- Evergrande) defaulted on it's debt's, They could just sell the properties they had on their books and easily cover all of these loans. 

➨This system works very well for rapid expansion and it is in theory a win-win for everyone.

But, As loans are made against real estates, this cause real estate price to rise and as the prices rise, large and large loans can be made against the real estate.

Some information about The Evergrande Group,

The Evergrande Group is one of the top real estate developer in china and it is ranked 122nd on fortune global 500.

➨ It is incorporated in Cyman island(it is self governing British overseas territory) and  Headquarter in Shenzhen, Guangdong Province, China.

➨ It was founded in 1996 by Xu Jiayin.

➨ Their primary focus has been on real estate development but they also quite active in other businesses like:-

* Tourism and recreation Business:- it owns two major theme park brand "Hengda children of the world" and "Hengda water world". and Ocean Flower Island in Hainan is one of its major project (under construction).

* Automobile Business:- In the year 2018 Evergrand acquired 45% stake in electric vehicle company "Faraday Future", in 2019 the company partnered with State Grid Corporation of China to develop electric vehicle charging stations. and in 2020, the company launched the "Hengchi electric vehicle brand.

* Sports Business:- In the year 2010, it acquired football club "Guangzhou Evergrande F.C and invested heavily to acquire top players. it also have a sports school Evergrande Football School.

* Mineral Water:- In the year 2014, Evergrande group launched its "Evergrande Spring" mineral water brand and invested 5.54 billion Chinese yuan.

* Health:- In the year 2015, Evergrande acquired New Media Group Holding and renamed it "Evergrande Health" and it operates "Evergrande Health Valley" a health ane wellness park.

* Finance:-  it owns shares in Shengjing bank, and in november 2015, it acquired a 50% stake in Singapore Great Eastern Life Insurance Company for $617 million and changed its name to "Evergrande Life".

* Entertainment Business:-  In the year 2014, HengTen Networks was formed in partnership with Tencent. etc.

➨This company has more than 1300 projects in 280 cities of china. and at this point of time this company owns 2% of all the newly constructed estate in china (residential apartments).

➨So it is a conglomerate mostly focused on real estate.

And Now Let's understand The Evergrande Crisis,

➤ Evergrande had seen that properties in china were appreciating at a rate of about 10 to 15% per year, so they wanted to push this limit to the extreme. They wanted to borrow more and more money to buy up more land rights, Pre-sale more apartments all in an attempt to grow as fast as possible.

➤ Evergrande is essentially a company who has borrowed hug amount of money and they have borrowed  it from everyone... Banks... Investors... Suppliers... Customers... Employees... and there is a good chance that the company is going to default the payment of interest on bonds they issued.

➤ All good thing must come to an end and that bring us back to august 2020 when the Chinese government introduced a new law in, to control the amount of debt that developers could take on and also how the money that companies like Evergrande were getting of Pre-sale could be used.

➤ The policy has an instant effect on property development firms, not only could they no longer borrow, but they were basically forced to quickly pay down their debt. 

➤ Unfortunately the business were not making money and Evergrande has not even reporting losses for the last several years. They were taking more and more debt and they were not reporting any losses and because of poor financial practice and no good and authentic auditing happening with the company:- 

➞ 1.5 Million apartments have been sold to people who paid money but these apartments have not been delivered to them. Now this company is under pressure to repay because everybody wanted their money back.

➞ The Evergrand's total liabilities rose to near about 1.97 trillion yuan (approx. 305 billion dollar). this is mainly to due to swelling bills to suppliers. cash and cash equivalents plunged to a six year low. Total 128 banks and 121 financial institutions landed this company and all of them got stressed because they are lenders and their money will not come back.

➞ At the peak, that is about 2.5 year back Evergrande Group's market cap was more than 50 billion dollar but today it is down to 5 billion dollar, nearly 90% fall of its value. 

Now the question is, Bankruptcy or Bailout??  

➠ Normally, when a big company goes bankrupt people typically looks at the company's capital structure and those with the most senior claims might get paid back first and the most junior claims might get nothing and the ones in the middle might get pennies on the dollar.

➠ Often the goal is to keep the core business running, so that the customers and suppliers might be treated better than is legally required. Creditors work with management to figure out a plan that provide the best overall recovery for everyone.

➠ In the Evergrande situation the Chinese government are signaling that there will not be a Bailout. but government officials can be expected to step in .

*Just for awareness in a week People's bank of china has pumped in $14 billion in Chinese market.   

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By Ray Dalio (CEO BRIDGE WATER ASSOCIATE):-

"It is not lehman movement because lehman movement produce pervasive structural damage through the system that wasn't rectified until the treasury came across and than the fed came across with Quantitative Easing.. But this is not that kind of shake, this is 300 billion dollar that they owe and this is all manageable"

Thank you Stay Happy and safe.......