What is Evergrande, and why is it important?
Evergrande is China's second-largest property developer, which quickly turned from “the world’s most valuable real estate company” in 2018 to the “world’s most indebted company” recently.
To fuel growth amid the Chinese real estate rally, the company leveraged hefty amounts of credit. Little it knew it would have faced the Covid-19 pandemic and a long-term slowdown in the Chinese property market, provoking a fast deterioration of the company's fundamentals. This year, a debt squeeze led to suppliers' payment delinquencies, putting the company at risk of default.
The Chinese market faces the problem that Evergrande is a bellwether for the real estate sector with over a thousand projects across the country and total liabilities of over $300 billion. A default poses funding problems to Chinese real estate corporates and the Chinese banking sector, which inevitably increased exposure to the real estate giant during the past decade.
As Citigroup indicated, Chinese developers will have problems refinancing debt in the onshore market because of low demand. Refinancing in the offshore market would also be unviable due to the recent spike of funding costs for Chinese high yield corporates in USD. According to Bloomberg Barclays Indexes, yields rose from roughly 8% in May to 13.70%, the highest since March 2020 as the Covid-19 pandemic was hitting the market.
The property market will undoubtedly go through a period of adjustments as the collapse of Evergrande could suppress property values. Yet, we do not expect the government to tolerate a full-blown out collapse as more than three-quarters of household wealth in China is tight up in the property market.
Banks are also vulnerable amid an Evergrande's default. They would see their balance sheets deteriorate amid an increase in non-performing loans.