China calls on local authorities to prepare for the fall of Evergrande

Evergrande Falling in Stock

It seems that the final decision from Beijing has arrived. Chinese authorities are asking local governments to prepare for the possible Evergrande crash, officials familiar with the negotiations have revealed exclusively to The Wall Street Journal (WSJ). This message makes it clear that the Government of China will not come to the rescue of the world’s most indebted property developer, which could have serious economic and social consequences in China.

Officials consulted by the WSJ have warned local authorities to “prepare for the possible storm.” Local government agencies and state-owned companies have been instructed to intervene to prevent a domino effect. In other words, Evergrande must be dropped but establishing the appropriate firewalls so that it does not drag down the real estate and banking sectors.

Confusing information about Evergrande

This morning some information leaked in which Chinese officials were pressuring the property developer to meet its financial obligations and complete the buildings that are still pending. This information has led the market to interpret that Evergrande was going to be rescued. Thus, the shares of the Chinese company have rebounded strongly in the early morning (European) of this Thursday, standing at 2.66 Hong Kong dollars, compared to the 2.27 in which they concluded last Tuesday.

This Thursday is one of the deadlines for Evergrande to face the payment of a coupon of 83.5 million dollars from its bonds. Investors have been pending this date for several weeks because the debt problems and little liquidity that Evergrande drags could cause the firm to default.

Despite all of the above, the latest information speaks of an upcoming orderly liquidation of the firm (as long as it fails to get ahead in some way), with the collaboration of local authorities, Chinese agencies, creditors and Evergrande itself.

Thus, central authorities (Beijing) have tasked local authorities with preventing potential disturbances orchestrated by home buyers and acting to cushion the impact on the overall economy, for example by limiting job losses.

Lawyers, accountants, economists…

Local governments have been directed to bring together groups of accountants, economists, technicians and legal experts to examine the operations and balance sheets of the companies that surround Evergrande in their respective regions.

Local governors will also need to speak with state and private developers in their regions to take over local real estate projects and try to appease the ire of people who may be left without the home they paid for.

Spokesmen for Evergrande and China’s cabinet information bureau, the State Council, have not responded to calls from the American daily The Wall Street Journal.

Evergrande’s liabilities reach 250,000 million euros. The risk of a domino effect on other developers and firms in the sector is on the rise and could be very dangerous due to the large size of China’s real estate sector.

According to data from the investment bank Nomura, the debt of Chinese developers was about 33.5 trillion yuan (4.4 trillion euros) at the end of the second quarter of 2021. On the other hand, China’s home mortgage loans totaled 36.6 trillion yuan (4.8 trillion euros) at the end of the second quarter of 2021, 13% more than at the end of the second quarter of 2020. To put these figures in perspective, China’s nominal GDP in 2020 was 101.6 trillion yuan (about 13.4 trillion euros).

Why is Evergrande collapsing?

Tom Wilson, Head of Emerging Markets Equities, Shroders explains that “Evergrande’s debt position has been building up over a number of years. In terms of liabilities (shown below), Evergrande is an outlier by comparison. with the real estate sector in general“.

Evergrande has a huge liquidity problem and a notable solvency problem. It has a cash flow problem because its cash flow is too small to deal with short-term debts, while its short-term cash generation is also limited by the huge stock of unfinished housing that it cannot sell at ordinary prices. But it is not only a liquidity problem.

“The company’s problems have reached their peak after the deleveraging framework that the government imposed on the largest real estate developers in August 2020. The developers had to place their debt levels below certain metrics or red lines”, assures Tom Wilson.

“These have started to take their toll in recent months and, in its latest earnings report, Evergrande already warned that its cash flow had deteriorated to the point that it could incur default. Consequently, the current situation is not the best. all unexpected”.

What can your bankruptcy mean?

The implications of its possible bankruptcy could be significant, as warned by Schroders. “The Chinese real estate sector accounts for 29% of total GDP. Therefore, there could be ramifications for the Chinese financial markets and the economy, while there have been some concerns about the broader contagion to other world markets.”

The uncertainty about Evergrande’s prospects comes in the context of broader government policy action. Regulation has more recently focused on areas such as the technology, internet, and private education industries, but the policy changes applicable to real estate date back much earlier.

Already in the short term, the growing uncertainty about the future of Evergrande, aggravated by the imminent debt restructuring, has led to an increase in credit spreads and a tightening of market access conditions.