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Understanding the magnitude of the Evergrande case

09/17/2021 | 06:47am EDT

We have been hearing about it for a few weeks, Evergrande, the giant of Chinese real estate developers is on the verge of bankruptcy. But why does this affair go beyond the country's borders?

Although it has not yet gone bankrupt, the world's rating agencies agree that the group will most probably not be able to honor its interests in the near future. On Wednesday September 15, Standard and Poor's revised its rating downwards once again, reducing it to "CC". 

Evergrande's total debt is just over $300 billion. It is quite normal for a property developer to have a very large total debt. Let's just focus on the interest-bearing debt, which is just over $122 billion. For comparison, Morocco's GDP is about $120bn, and Alphabet's net income in 2020 was close to $40bn. But what is even more worrying is that this short-term debt involves 128 banks and financial institutions. This justifies Beijing's concerns, which fear a crisis in the financial system in the event of Evergrande's bankruptcy.

In addition, nearly 8,500 companies work with the real estate group, and therefore have debts or orders with it. All these companies would be affected by a bankruptcy of the real estate group and could consequently suffer from serious financial problems. But in addition to taking banks and companies down with it, the Chinese property developer could have many collateral effects on households and workers. In 2020, Evergrande employed about 140,000 workers and indirectly created 3.31 million jobs. In addition, 2 million households have already paid for their homes before they are built. In the event of bankruptcy, this clientele could, once again, experience major complications.

Risks are numerous and significant for the Chinese state. This is why, from now on, the CCP has set strict debt rules called "Three Red Lines", a color that suits the regime:

  • Debt/Asset Ratio below 70%.
  • Net debt to equity ratio below 550%.
  • Cash/Short-term debt ratio above 100%.

Even though Evergrande is selling off its properties at -30% in order to recover cash as quickly as possible and to be able to honor its interests, the group does not meet any of these three criteria.

  • Debt/Asset ratio = 84%
  • Net debt/Equity ratio = 550%
  • Cash/Short-term debt ratio = 12%

As you can see, a collapse of Evergrande would lead to serious economic and financial complications (Impact on the financial system, economic crisis, bankruptcy of companies...). Evergrande's managers are well aware of all these risks and are using them as a lever to blackmail the CCP. Indeed, the real estate group published a letter on August 24, explaining at length that if the State does not save them, they will drag everyone down with them.

 

To be continued...

 


© MarketScreener.com 2021
Stocks mentioned in the article
ChangeLast1st jan.
ALPHABET INC. -1.02% 2835.38 Delayed Quote.61.78%
CHINA EVERGRANDE GROUP -3.91% 2.95 End-of-day quote.-80.20%
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