2021 China's Evergrande crisis and its ripple effects

Here is a wonderful thread from Sahil that you can read on Twitter here. 

Evergrande is the train wreck that the financial world and media can’t help but watch. Here’s breakdown on the story:

The Evergrande Group is a Fortune 500 real-estate developer with headquarters in Shenzhen, Guangdong, China. It was founded by Hui Ka Yan in 1996 in Guangzhou. It's a big business: as recently as 2020, it had sales of >$100 billion and adjusted core profits of ~$5 billion. 

At its core, it's a homebuilder business.Its website states that it has over 1,300 projects across 280+ cities. But it has pushed the boundaries, making investments in EVs, an internet and media production company, a theme park, a soccer club, and a mineral water company.

As a developer, Evergrande had to contend with a highly cash-consumptive growth profile. Building a new project may take many months and requires a lot of cash outflows along the way. Cash collections (from buyers) come later, with the exception of smaller upfront deposits.

So how did Evergrande fund its impressive growth? Debt—it borrowed aggressively, even by real estate property development standards. It became the world's most heavily-indebted developer, with a debt load of over $100 billion and over $300 billion in liabilities.

As is pointed out in the brilliant thread below, there is a bit of a moral hazard problem that was created along the way. Evergrande was largely indifferent to pricing on the land it was purchasing, knowing that the risk would be passed off to banks financing the purchases.

The debt-fueled growth propelled Evergrande (and its now billionaire founder) into an elite class. It entered the Fortune 500 at #496 in 2016 and reached #122 by the latest ranking. But debt is a double-edged sword—and Evergrande was due to catch the other edge.

As its debt burden grew, so did the interest payments on that debt. This is (mostly) fine, so long as revenues and profits—with which you can make these payments—continue to grow. But if the growth or profitability slows (or government restricts borrowing!), it's...not fine. 

Imagine a metaphorical boa constrictor tightening its grip on its prey. You can try to borrow more to make your payments, but that only fuels the snake. Moreover, the knowledge of your precarious position increases risk and makes that borrowing more challenging and costly. 

In Evergrande's case, the snake tightened its grip in 2020. It had its first major liquidity scare—a potential inability to meet its liabilities—sending a letter to the local government warning that upcoming payments could cause a crisis with systemic financial sector risks.

As with most de-leveraging spirals, there is a technical side (inability to make payments) and a psychological side (the knowledge of instability impacting your market standing). The psychological is damning. Reports of the letter sent Evergrande’s stock and bonds tumbling.

The short-term crisis was avoided—an investor group didn't force a big repayment—but the long-term remained.Dornbusch's Law says that crises take longer to happen than you expect, but then happen faster than you ever could have imagined. This proved true for Evergrande...

To meet its ever growing obligations, Evergrande began tapping into "creative" financing strategies. It pushed employees to provide short-term loans to the company—which it called "high interest investments”—in order to ensure they received their year-end bonuses.

But the company quickly fell behind, missing payments earlier this month and leaving thousands of employees in a lurch. With over $7.4 billion of bond payments due in 2022, and large interest payments coming up as soon as this Thursday, the crisis appears to be accelerating.

To reiterate, the psychological side is just as impactful as the technical. It was recently reported that Evergrande was offering to sell properties at a deep discount—indicating a fire sale required to make its payments and sending further panic spiraling into the market.

Protests have broken out at Evergrande offices in China—with up to 1 million homebuyers left in a devastating limbo, having paid deposits upfront for homes that may never be built. The media narrative cycle of demise ramped up in earnest and further fueled the fire. 

Importantly, the Evergrande situation poses a systemic risk to the Chinese economy. With deep ties to financial institutions and working class consumers across China, a disorderly collapse would have far-reaching impacts (financially and emotionally). 

But China is caught in a very tough spot. Act quickly with a bailout and be viewed as condoning the financial excess that led to the problem. Fail to act and allow the collapse to ripple through the entire economy that is just recovering from COVID shocks of 2020/21.

The Evergrande situation will undoubtedly continue to play out in public in the days and weeks to come. For more on this story, check out the resources below: 

https://www.bloomberg.com/news/articles/2021-09-13/what-is-china-evergrande-and-why-is-it-in-trouble-quicktake?sref=UGGkDWbK … 

https://www.wsj.com/articles/how-beijings-debt-clampdown-shook-the-foundation-of-a-real-estate-colossus-11631957400 …19/ 

EVERGRANDE WATCH — UPDATE: Evergrande issued a hazy statement on Wednesday, stating that the interest payment due Thursday on one Yuan-denominated bonds “has been resolved via negotiations off the clearing house.” No other specifics were offered.What does this mean? The clearing house is a centralized authority through which Chinese companies typically pay interest on their local currency-denominated bonds. Direct repayment—as is implied here—is generally only used in cases where the company is looking for a special payment arrangement. This effectively provides a company like Evergrande with a way to make a payment out of formula with the actual bond terms while avoiding technical default. The proverbial can has been kicked down the road…for now. 

EVERGRANDE UPDATE: Trading on Evergrande shares was halted pending an announcement of a transaction. Reports indicate that Chinese developer Hopson Development Holdings will acquire 51% of Evergrande’s property-services unit for ~$5.1 billion (~28% discount to market value). Evergrande had spun-off the property-services unit in December—raising ~$1.8 billion in that transaction. While providing some relief, Evergrande has another $260 million bond payment due today, and it remains unclear whether recent bond payments due have been paid in full. Where there’s smoke, there’s fire...

Fantasia Holdings Group—a Chinese luxury property developer—missed a $206 million bond payment and a private bond payment yesterday. Fitch downgraded Fantasia to “restricted default” after the misses.

👀 on the Chinese property sector.

Obama won - Now what?

It has been noted across the world and in the history books, that President-elect Barack Obama is the 1st Black president of the United States of America. But how united really is the US? As this history was made, there was another statistic dramatically on the rise and it is marked by a strong current of racism. There have been numerous death-threats by white supremacist to assassinate Obama!

It was announced on CNN after the election that the FBI had noted that the increase in number of death threats spiked each time the Republican GOP VP candidate Sarah Palin held a rally during the election campaign. These rallies frequently were associated with white people shouting slogans of "terrorist" and "kill him" - (see it here). The tone of her campaign was so vicious and negative, it even drew sharp criticism from the McCain camp and Palin was asked to tone down her rallies - which were nothing short of provoking racism. Even while this was happening at Palin rallies, many people were asking McCain in town hall meetings "How come Obama is ahead? How is this happening?". It is clear from these questions that no republican expected Obama to really win the election because of his colour. Right before election day, there were talks of a "surprise" election outcome from the McCain camp. These were based on hopes that on election day, white voters registered as Democrats would go and vote for McCain because they would be "uncomfortable" voting a black man for President. (After the election, it seems like the opposite happened as white people who would never openly admit voting for a black man went and cast their votes for Obama - because of his policies and his promise of change.) It is no doubt that this will severely anger white fanatics who still believe they are a superior race. It is not surprising to see an increase in KKK activity in recent times.

In a meeting between the US President Bush and President-elect Obama, Bush's choice of words for Obama was very interesting. Pay careful attention to the last para of this article, Do you think I am reading too much into things? Bush has held the most powerful chair in the world for 8 years and while his intelligence can be easily questioned, the man has to be adept at the art of conversation simply because he has to meet with leaders from a diverse background from across the globe. At that level, what you say, how you say it, even what don't you say and what words you use to convey a message is put under a microscope! I strongly suspect that Bush's choice of words when talking to Obama was a mere coincidence. I think Bush was sending a message on behalf of the Republicans.

However, Race is merely a weapon used by the wealthy to manipulate to masses for their personal benefit. There are other reasons for which I suspect that Obama could be assassinated. Obama is a natural leader. He has been elected on a campaign of "change". The economic situation is grim in the US. The US market is in a severe recession and a large number of people are losing their jobs. Those who still have jobs, do not know how long they can keep them. The sentiment of the common person in US is very bad. A vast majority are depressed and angry at the way the "leaders" have put the US in debt and have then gone ahead and bailed out Wall Street - with their hard earned money of Main street. The average person is also appalled at the way the CEOs have continued to mint money while the companies bled and employees were rendered jobless.

Even as he joins the office, Obama has his work cut out for him. He will have to turn things around and he will have to do that quickly. He will have to find a way to finance his promise of change by increasing taxes on the rich and giving a break to the common man. The problem is that change will not be easy to come by - the rich hold a lot of power. If change is ushered in too quick, it will be easy for the wealthy to manipulate the angry, unemployed masses, give them a racist cause and stick a pitch-fork in their hands.

What Obama needs to do is to tactfully please these two groups and bring them together. He needs to ensure that the United States are really united and that there is no division of people along racial, economic or along any line as America goes thru economic stagnation/recession and deflation. He needs to emerge as a leader that gives the people a sense of direction - a La John F. Kennedy! This is why Americans are sold on Obama - because they believe this man is a better leader than John McCain. Americans have done their part - Now the ball is in Obama's court. I hope he delivers on his election promises!

Comments and brickbats welcome - Just don't bring a pitch-fork please.