China Faces a Real Estate Reckoning with Evergrande Default Imminent

The ongoing collapse of China’s Evergrande Property Group is the top financial headline around the world, as the firm faces an almost certain default. Though some are quick to point out that Evergrande is a relatively small piece of a heavily fragmented Chinese real estate market, it’s still one of the top 3 domestic developers and emblematic of the wild speculation that’s characterized the country’s ever-inflating property bubble.

Contagion is a very real threat for China’s economy, with real estate activity making up 20-30% of the country’s GDP. Negative sentiment surrounding Evergrande’s lack of liquidity has already crashed at least one other heavily-indebted property developer. If Beijing does not step in to provide a bailout or restructuring plan, the red-hot industry could come to a screeching halt.

Related ETFs & Stocks: iShares MSCI China ETF (MCHI), Global X MSCI China Real Estate ETF (CHIR), Sinic Holdings Company Limited (2103.HK), China Evergrande Group (3333.HK)

MRP has covered growing bubbles in China’s real estate market and financial sector for several years now. The ongoing collapse of Evergrande Real Estate Group is the latest symptom of runaway speculation, and a broader weakness that now appears to be gripping the Chinese economy.

Evergrande is China’s second largest property developer by sales, the leading issuer of high-yield notes in Asia, and the world’s most indebted property developer. With shares of the company breaking down to a new low on Tuesday morning, the firm has a market capitalization of about $3.9 billion. That compares to $90 billion in debt on its balance sheet, and $300 billion when including unpaid bills.

Fears of an imminent default have vaulted Evergrande into global headlines over the past couple of weeks, as they were scheduled to pay interest on bank loans on Monday, with a one-day grace period. Since Monday and Tuesday are public holidays in China, we may have to wait until Wednesday for a resolution. However, Chinese authorities have already told major lenders not to expect repayment.

More tests of Evergrande’s liquidity are set for later this week, with the group due to pay $83.5 million of interest on an 8.25%, five-year dollar bond. Though the Sydney Morning Herald notes that the bond’s covenants stipulate a 30-day grace period before that missed payment would technically be considered a default, the writing will be on the wall if no liquidity can be supplied quickly. Evergrande will also need to pay a coupon worth $50 million on an onshore bond that same day.

Additionally, it has another $47.5 million payment due on September 29 for March 2024 notes. In total, Evergrande owes a whopping $669 million in coupon payments coming due through the end of this year. Unsurprisingly, Moody’s Investors Service and Fitch Ratings have each downgraded Evergrande this month, indicating an increasing likelihood of default on the horizon.

Macro strategists at Swiss bank UBS have noted that they now view a credit default as unavoidable. Should total liquidation happen, the spillover would be significant, and the bank’s strategists say a “high degree of contagion” is expected. Barron’s notes that a domino effect of other defaults could be initiated, because both banks and other groups with large exposure to Evergrande face the threat of bankruptcy or restructuring.

S&P Global Ratings says support from the Chinese government appears to be unlikely – but they are less concerned with contagion. Per an S&P report from yesterday, “We believe Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy… Evergrande failing alone would unlikely result in such a scenario.”

While analysts across the world are split on how widespread the damage from an Evergrande default would be, at least one other property developer is already being dragged down alongside it. Hong Kong listed shares of Shanghai-based developer Sinic Holdings Group Co. cratered 87% lower before being halted Monday, the first major sign of contagion spreading across China’s real estate sector. It was a week ago that…