Chinese Real Estate Sector In Crisis As Evergrande Collapses

Key takeaways

• Chinese property developer Evergrande has filed for Chapter 15 bankruptcy protection in the U.S.
• China’s debt crisis, sparked by the property sector, is making investors uneasy that the world’s second-largest economy is faltering
• The Hang Seng Index is in a bear market, and large Chinese company stocks have fallen across the board

Is China about to have its ‘Lehman’ moment? After Chinese property developer Evergrande filed for bankruptcy protection in the U.S., that’s been the question some have whispered. The country’s debt crisis that’s rumbled on for two years is coming to a head, with China’s shadow bank sector now defaulting on payments.

China has the second-biggest economy, which has prompted fears that an economic slowdown could spark another global recession. The Chinese government says it has things under control, even though outside of the debt crisis, the post-lockdown economic recovery hasn’t taken off. Here’s the latest.

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What’s happening with Evergrande?

Last week, Evergrande filed for protection in the U.S. under Chapter 15 of the bankruptcy code, which helps keep creditors at bay when a company is restructuring. Evergrande’s debt is held mainly by Western investors, hence filing in Manhattan.

It’s been at the center of the Chinese property sector’s debt crisis, which first unfolded in 2021 and has reared its head again this summer. Nearly two years ago, Evergrande defaulted on making interest payments on bonds, which sparked a set of failures across the Chinese property sector.

Companies accounting for roughly 40% of China’s home sales have now defaulted on debt since the crisis first unfolded. This has led to unfinished homes and ‘ghost cities’, supply chain disruptions and institutional investors out of pocket.

Evergrande’s board has tried to reassure everyone the company is peachy. “The application is a normal procedure for the offshore debt restructuring and does not involve bankruptcy petition”, the statement said.

It’s not the only property developer struggling this week. China’s Country Garden Holdings is looking to restructure its bond repayments totaling $535 million over three years to stave off financial trouble.

Can Evergrande’s EV business help?

Evergrande isn’t just known for being a real estate developer – it’s also an EV car maker, and the division has suffered due to the ongoing turmoil in the company’s real estate business.

Last week, Evergrande confirmed its EV arm, China Evergrande New Energy Vehicle Group (NEV), was issuing new shares to specific subscribers to ease the company’s substantial debt burden. The 5.44 billion new shares will be priced at HK $3.84 per share for a total of HK $20.89 billion (US $2.67 billion).

NEV has also agreed to issue 6.18 billion new shares to the U.S.-listed NWTN, a Dubai mobility firm, for around $500 million. The business has taken out an interest-free loan of 600 million yuan (US $82.6 million) from NWTN, who will hold around a 27.5% stake in NEV going forward.

If Evergrande collapses, it’s possible that NWTN could acquire the EV business altogether. The company has been on thin ice for some time – Evergrande NEV posted a combined net loss of 84 billion yuan in 2021 and 2022 and has delivered fewer than 1,000 units of its Hengchi 5 model since its launch in October last year.

China’s sluggish economic recovery

Given real estate is estimated to make up 30% of China’s GDP, there are fears the contagion in China’s real estate market could spread and create a downward spiral of the property market depressing growth.

Last week, there were rare protests in Beijing after bank subsidiary Zhongrong defaulted on several investment products without immediate plans to repay its clients. Its parent company, Zhongzhi, manages $138 billion in assets, 10% of which are exposed to the real estate market.

Moody’s has previously stated that the increased amount of defaults from property developers has raised Chinese banks’ non-performing loan rate to 4.4% by the end of last year, up from 1.9% in 2020. China’s property sector is also considered the world’s largest asset class, worth around $62 trillion, so any further signs of trouble could lead to the Chinese government intervening.

Aside from the debt crisis, China’s economy has struggled to rebound since Covid. Consumer prices fell for the first time in two years in July, prompting fears of deflation in the Chinese economy. The Chinese yuan has slumped in value, and house sales have fallen 6.5% in 2023. The unemployment rate for young Chinese workers hit a 21.3% high in June, and after that, the Chinese government stopped sharing the figures.

How did the markets react?

The iShares MSCI China ETF has dropped 13% in value this month alone, and other large Chinese companies have also suffered – including tech companies. Alibaba fell 3.4% on Friday, Baidu shares lost 2.7% in value and JD.com plunged 5.3%.

As for the Hang Seng Index in Hong Kong, it’s officially entered a bear market. Around half the stocks on the index are now oversold, and it’s lost 11% of its value in August so far, which sets the scene for the Hang Seng’s worst performance since October.

The fear has spread to the U.S. markets in August, with the S&P 500 suffering three straight weeks of decline. The Nasdaq lost 5.5% in value in the same period, while the Dow Jones has seen a 3.2% decline.

Several banks have also downgraded China’s GDP growth outlook, which was previously estimated at 5% for 2023. Nomura now predicts 4.8% growth, with the likes of Morgan Stanley, JPMorgan and Barclays all following suit.

The bottom line

China is grappling with some severe economic troubles right now. While the debt crisis in the property sector has been rumbling on for some time, the surprise slowdown in economic activity after lifting Covid restrictions has made a bad situation worse.

In the coming weeks, we could see more Chinese financial institutions default on their payment obligations and perhaps see Evergrande collapse into bankruptcy – which would affect Western creditors. As it stands, the stock market won’t be picking up any time soon while this is going on.

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