Global markets wobbled this week, as the debt woes of a single Chinese property company sparked fears of a new financial crisis, writes Adam Maguire.
Markets around the world trembled this week over concerns that problems in China's property market could morph into a crisis for the global economy.
At the centre of the panic was Evergrande Group - a company that would have been largely unknown to Irish consumers before now, despite it being a major cog in the Chinese economy.
What is Evergrande Group?
Evergrande Group is a massive conglomerate that has operations in a number of areas.
It’s involved in farming, renewable energy and health - and even owns amusement parks, a bottled water brand and half of the most valuable soccer club in China.
However the heart of its business is property, with Evergrande in recent years ranked as the biggest real estate business in the world in terms of asset values.
Its website claims the group currently owns more than 1,300 projects across 280 Chinese cities, with more than 400 million square meters of space under its management.
Among that is the Ocean Flower Island project in Hainan; made up of seven man-made islands containing 58 hotels, 28 museums and a 127,000 square meter theme park.
But amassing its portfolio has come at a cost - with the company currently owing investors, bond holders and others more than $305 billion.
Debt becomes them
That debt pile is massive by any metric. But markets don’t tend to worry too much about these things as long as the debtor is able to pay up when money is due.
That’s the problem with Evergrande; it can no longer guarantee it will be able to do so.
Just over a week ago the property company announced that it was struggling to raise cash, despite trying desperately to sell more of the homes it was building.
At the same time, tighter regulations in China means the company’s capacity to borrow more has been severely limited.
If it cannot get cash, it becomes difficult for it to meet its debt obligations. And that raises the prospect of it defaulting on its loans in the near future.
A huge company defaulting would be problematic in and of itself but Evergrande’s current predicament is emblematic of the entire sector in China.
And property is a major part of China’s economy - real estate recently accounted for 29% of China’s GDP. Much of that was fuelled by companies - like Evergrande - taking on massive debts in order to fund vast construction projects.
That model may make sense when there is the strong prospect of the resulting properties being sold, but the Chinese market is now significantly over-supplied.
Logan Wright, a Hong Kong-based director at consultancy firm Rhodium Group, recently told The Financial Times that he estimated there was enough empty property in China to house 90 million people.
That is in addition to the second and even third homes owned by China’s growing middle and upper classes, and is despite recent videos showing multiple, unfinished high-rise developments being demolished.
Like many companies - and countries - Evergrande’s liabilities are made up of multiple loans and bonds. That means its repayment obligations fall in stages - not in one big lump.
Thursday gone was a deadline for interest repayments on two of its bonds - one domestic and another based overseas - the first staging post since its debt warning.
Ahead of that deadline the company announced that it had 'resolved’ one of the repayments. Details of what that meant were limited, but it doesn’t necessarily mean the payment was made. It is also possible that Evergrande and its bond-holder(s) agreed to delay repayment, perhaps in return for a higher interest rate.
However it missed the deadline on its overseas bond - increasing fears that it was heading towards a default.
With another interest repayment scheduled for the coming week, the risk is that its debt problems will quickly begin to snowball.
In a state of grace
Evergrande’s repayment deadlines come with a 30 day grace period - giving the company a small bit of breathing space before it technically defaults.
However that grace period happens to include a seven-day long national holiday in China, which will mean an extended period of limited market activity in the country.
If it reaches the end of the period without making a repayment, and officially defaults, it will send ripples in a number of directions within China’s economy.
Cross-default provisions mean that a missed deadline one bond may spark a default on others, so that may see multiple Evergrande loans going bad in one go.
On the ground, customers who have pre-paid for Evergrande property will probably lose what little hope they have of ever seeing their homes built. Meanwhile suppliers who have been contracted to work on its projects won’t get paid.
On the financial side, it’s believed that as many as 171 Chinese banks and 121 financial firms are owed money by Evergrande. They would face having to write-down - or completely write-off - the money they’ve put into the firm.
China, all the way to New York
A relatively small proportion of Evergrande’s liabilities are held outside of China - though the company has made clear that it will prioritise domestic investors, meaning those that are based overseas are at a higher risk.
As a result, international financial firms have been queuing up in recent days to assure investors that they are not heavily exposed to the firm.
Credit Suisse says it does not hold much of the company’s debt, UBS says it risk is "immaterial" while Deutsche Bank said it has not been "directed affected" by the events of the past week.
But while American and European finance firms may not be directly linked to Evergrande, it is unlikely they would emerge completely unscathed should the firm collapse.
For a start, while Evergrande may be the biggest problem in Chinese property market at the moment - it’s not the only one.
There are many more indebted firms in the market that will be finding it just as hard to sell properties and raise cash. The fear is that Evergrande is only the tip of the iceberg, raising the prospect of more defaults, more unfinished homes and more unpaid suppliers.
Any Chinese firm that is heavily exposed to property will face financial pressures of its own should it have to write-down those investments.
That could spark a domino effect in China’s financial system, and it wouldn’t take long for that to impact on the investments made by companies based on this side of the world.
But even if any contagion is somehow contained within China’s borders, the impact it has on the country would still be bad news for the rest of the world.
Plunging property values, bad loans, companies going bust, and would-be homeowners losing deposits are a familiar scenario to Ireland - and what it means for an economy is hard to forget.
China’s importance to global GDP means that any slowdown or decline in its economy will be felt globally.
That toxic mixture would also severely suppress consumer spending in the country. Many American and European consumer brands - from tech firms to infant formula producers - earn a lot of money from Chinese buyers, so that would do significant damage to their revenues and profits too.
Long way from home
Evergrande’s CEO has expressed confidence that the company will emerge from its current crisis - but markets are far from sure about that.
If it can’t convince people to buy homes, and can’t borrow more, cash will remain hard to come by.
Convincing someone else to stump up is also unlikely, as size of the company makes it hard for any white knight to come to its rescue.
Meanwhile the current state of the Chinese property market will make it hard for the firm to convince investors that it will be in a position repay its debts down the line, should they be willing to renegotiate terms.
Instead, many believe that its only real hope of survival would come in the form of a government bailout - but so far there has been no sign of that happening.
Market watchers aren’t getting their hopes up, either, as a state intervention would run counter to the hard line China’s leadership has taken against its profit-hungry big businesses in recent times. It would also create a precedent that could come back to haunt the country if all those other indebted property firms begin to have troubles of their own.
Instead, China’s focus so far has been on maintaining liquidity in the rest of the system, with the central bank there pumping almost 19 billion dollars in cash into the market.
But bailout or not, it will almost certainly have to do more than that if the Evergrande story continues on its downward trajectory.