The main fallout from a collapse of Evergrande, a global real estate giant, will be political and social, analysts agree. For them, the Chinese state cannot fail to intervene.
But first of all, how did it come to this? The main reasons are mismanagement, risky diversifications, the allure of easy money and even a certain megalomania on the part of Evergrande's leaders, and the slowdown in Chinese growth. But above all, after decades of easy money, the government has taken new measures to curb property speculation.
Borrowing ratios have been tightened, large promoters have been forced to reduce their debt levels below certain parameters known as "red lines" and, above all, they can no longer sell a property before it has been completed. This was Evergrande's business model.
Stock market collapse
Growing uncertainty about Evergrande's future, exacerbated by the impending restructuring of its nearly $300bn in accumulated debt, has led to widening credit spreads and tighter market access conditions.
“In recent weeks, declining property sales and disappointing progress on asset disposals have led to a further deterioration in the company's position. Continued negative news, combined with weak market sentiment, has led to a downward spiral, and the company's funding channels have all but closed, significantly undermining investor confidence in Evergrande,” says Schroders.
The company's stock has fallen 85% since the beginning of the year and 48% since the beginning of September, dragging down the MSCI China Index, which has lost 5.7%. The yield on its 5-year US dollar bond has risen to over 560%.
What would be the fallout if the company collapsed?
There is a clear risk that confidence will take a hit and weigh on the already weak recovery in consumption.
Robin Parbrook, manager of the Asian Equities fund, says: "A default could lead to the collapse of many of its commercial peers in the supply chain and push up non-performing loan ratios in the Chinese banking system. A default by Evergrande could also lead to a significant delay in the delivery of these homes and have social repercussions." According to observers, a failure would mean 1.4 million unfinished homes with a total value of €170bn.
Another foreseeable consequence is that "construction activity, which has already weakened considerably in recent months, could remain depressed if Evergrande and other developers do not have the capacity to deliver units that have already been sold," says David Rees, senior economist for emerging markets. This could in turn trigger a fall in property prices, which in turn could lead to a drying up of pre-sales of new projects, adding to the stress in a sector that still accounts for 29% of GDP. "There is a clear risk that confidence will take a hit and weigh on the already weak recovery in consumption."
These are consequences that seem unthinkable to the Chinese government, which is starting to act even if covertly.
An Evergrande credit event could be managed by regulators without causing significant contagion risks to the wider economy.
For example, Roy Diao, head of fixed income for Asia, believes "some form of government facilitation is likely to maintain order during debt restructuring or even a potential default scenario". On the ground, there have already been some signs of this happening. The Chinese government has centralised legal cases against Evergrande in a court in Guangzhou to reduce operational disruption, and has also coordinated negotiations with stakeholders to resume construction on some property projects.
"As policymakers already have experience of previous large restructurings, such as Anbang Insurance, we believe an Evergrande credit event could be managed by regulators without causing significant contagion risks to the wider economy," says Diao.
The aim seems to be to limit the economic fallout and save some creditors.
The business model of the Chinese property development market is pre-sales.
"The business model of the Chinese property development market is pre-sales. Therefore, Evergrande's failure will leave many buyers without the flats they have already paid for. We therefore expect the government to split up Evergrande's projects and ask state-owned enterprises (SOEs) or quasi-SOEs to take them over. This is already happening, for example, in Shenzhen. Banks may have to take write-downs on their loans to Evergrande, but in the long run losses should be limited as the loans are mostly secured. Finally, the provincial authorities are also likely to support Evergrande's contractors and suppliers," says Tom Wilson, head of emerging markets equities.
So what about a possible contagion effect to other global economies?
Evergrande's problems could have an indirect impact on other economies, mainly in the emerging world.
Rees says on this topic: "A direct impact on other economies would likely be due to a drop in demand for commodities if construction activity were to weaken further. This would be of particular concern for economies such as Brazil, Chile and South Africa that export industrial metals to China. Evergrande's problems could have an indirect impact on other economies, mainly in the emerging world, if they were to dampen sentiment and trigger a 'sudden stop' in capital flows, but we are not there yet."
A limited fallout all in all.
In terms of markets, Schroders notes that while the company is a notable issuer in the Asian high yield market, its size remains modest. "In the major equity indices, its representation is minimal, as it is in the emerging market corporate bond indices."
"With Evergrande being the largest high yield bond issuer in China, we have already seen some impact on Asian and global high yield debt spreads, but this should be temporary. If there is a more prolonged downturn in the Chinese property market, some commodity prices could be negatively affected," says Wilson, head of emerging markets equities.
Indeed, the metals market, whose biggest customer is the Chinese construction sector, is beginning to be impacted. In Singapore, iron ore has fallen by 30% since the beginning of September, dropping below the symbolic $100 mark. In London, copper has lost 7% in a few days. As for the rise in aluminium, it has stalled.
Sentiment towards the Chinese property sector remains depressed.
On the equity front, "overall sentiment towards the Chinese property sector remains depressed," notes Robin Parbrook, manager of the Asian Equities fund. This pessimism is also affecting downstream players in the property supply chain, including appliance and furniture suppliers.
"We continue to have an unfavourable view of the Chinese real estate sector, as the sector is highly regulated and stricter policies are being implemented in various cities in China. The Chinese government's ongoing efforts to de-leverage the property sector could also put continued pressure on the sector's liquidity."
This story was first published in French on Paperjam. It has been translated and edited for Delano.