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Chinese property giant Evergrande has a huge debt problem – here's why you should care - YouTube
Channel: CNBC International
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Imagine you’re an investor or a supplier
dealing with one of the world’s most valuable
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property developers.
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Or being one of its 200,000 employees.
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Then, you find out that that very company
is also the most indebted property developer
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in the world, to the tune of $300 billion.
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As Evergrande teeters on the edge of default,
collapse would have grave consequences for
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hundreds of thousands of property buyers and
retail customers.
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After years of borrowing to fuel its rapid
growth, Chinese behemoth Evergrande is facing
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a major crisis, spooking markets and prompting
comparisons to the collapse of U.S. investment
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bank Lehman Brothers in 2008.
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So, is this China’s “Lehman brothers”
moment?
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Emily Tan, CNBC’s senior correspondent for
our Hong Kong bureau, has been in the thick
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of the action since the warning signs emerged.
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Emily, you’re one of the best people I know
to clue us in into what’s going on with
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the Evergrande crisis.
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So thanks for doing this.
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It’s good to be here.
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I think to understand the whole scale of it,
we have to start from the beginning.
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So what is Evergrande, and is it just a real
estate company?
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Evergrande was founded by Hui Ka Yan in 1996
in Guangzhou and basically rode China’s
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property boom.
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Evergrande is one of China’s largest real
estate developers.
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It is number two by sales.
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It is listed in Hong Kong but based in Shenzhen.
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It owns more than 1,300 residential projects
across more than 280 cities.
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And as it has made its name in residential
property, it also has interests in electric
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vehicles to theme parks from insurance, even
to bottled water.
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It also has a soccer team, Guangzhou FC, which
built the world’s biggest soccer school
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and has a soccer stadium under construction
to go with it.
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The warning signs of a potential collapse
appeared as early as 2018, when Evergrande
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was flagged as a risk by China’s central
bank.
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So how did it get to this point of incurring
such a big debt?
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Evergrande borrowed to finance all of its
pursuits and its debt ballooned.
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It has since accumulated over $300 billion
in debt, giving it the title of the world’s
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most indebted developer.
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You can compare that with Russia’s state
debt of $257 billion in 2020.
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It also sold $6.5 billion in high yield management
products, and that’s to an estimated 80,000 investors.
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And then there’s the homebuyers that pre-paid
for 1.6 million flats that have still yet
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to be delivered.
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I wanted to talk about China’s three red
lines, right.
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And it’s part of their policy to improve
the financial health of the real estate sector.
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Would you be able to give a brief explanation?
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There are these three red lines.
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The government developed this system to curb
borrowing.
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First, to ensure a liability to asset ratio
of less than 70%.
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Then, the next line, net gearing ratio of
less than 100%.
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And the third line, cash to short-term debt
ratio of at least one.
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If you cross all three of these lines, which
Evergrande does, this will restrict you from
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borrowing more money.
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Besides being at the mercy of these policies,
what else caused Evergrande to be where it is today?
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A few years ago, China's most acquisitive
companies were all forced to downsize following
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debt-fuelled shopping sprees.
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Names like Dalian Wanda, Anbang, HNA and Fosun.
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Evergrande has warned investors about its
cashflow issues and in September, even flagged
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depressed flat sales, and it was having trouble
finding buyers for all of its assets.
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Evergrande recently stopped repaying investors
and suppliers, halting building work at its
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housing projects, and we've also heard reports
now that it has stopped paying employees and suppliers.
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We've seen protests, and they've showed up
in their Shenzhen headquarters demanding payments
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on their wealth management products
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Evergrande has recently hired a debt restructuring
company, Houlihan Lokey, who has advised names
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like Lehman, Enron and WorldCom.
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If the talk of a potential economic downturn
triggered by a housing bubble sounds familiar,
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it’s because it is.
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13 years ago, the U.S. subprime mortgage crisis
culminated with the largest bankruptcy filing
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in U.S. history then, which led to the global
financial crisis.
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What is the domino effect of the Evergrande
crisis?
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We’re gonna be watching the effects on homebuyers
as well as investors, because we have some
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buyers paying mortgages on projects that have
been suspended.
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And then there are the banks, there are some
125 financial institutions, 121 non-financial
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institutions with liabilities.
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Then there’s the suppliers.
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For example, if you look at some of these
suppliers in Japan, toilet maker Toto is likely
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a supplier, as China accounted for 30% of
its profits in 2020.
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And then there’s the air conditioning manufacturer
Daikin, which gets 25% of its sales from China.
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Then there are some real estate developers,
and some of them are highly distressed real
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estate companies, at the risk of collapse.
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They are tiny, on their own, but collectively
they make up 10 – 15% of the total market.
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Analysts say if they do collapse, this could
result in a systemic spill over to other parts
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of the economy.
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Then, we worry about the financial system.
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Li Daokui, he’s a former advisor to the
PBOC, he expects minimal spill over to the
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financial system, and that’s because there
aren’t derivative instruments built on the
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Evergrande debt.
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Derivatives are financial contracts that derive
their value from the prices of other things,
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such as stocks, mortgages, currencies or commodities
such as a barrel of oil.
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These instruments are generally used to minimize
investment risks or for speculation.
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So people ask, will this be a Lehman event?
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Well, because there are no derivative instruments,
we shouldn’t see it play out in exactly
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the same way, but economic growth
will take a hit.
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Then there’s the shareholders, Chinese Estates.
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It is the biggest shareholder behind the company’s
chairman Hui Ka Yan, and they announced their
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intention to sell down their entire stake
in the company.
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They said that the company’s directors are
cautious and concerned about recent developments.
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Real estate in China is estimated to account
for more than a quarter of the country’s
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GDP, so any fallout will result in many angry
investors, doomed businesses and a very worried
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government.
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But, can the property market be stabilized?
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So everyone’s asking whether or not there
will be a government bailout, no one is really
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sure.
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But here are a couple of signs indicating
that we may not see that.
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The editor-in-chief at the Global Times, which
is a publication viewed as a Communist Party
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mouthpiece, declared Evergrande, quote unquote,
“not too big to fail”.
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And so, the company should not count on a
bailout.
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But then there's also policymakers that have
told lenders to extend their payment deadlines
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and rollover loans to Evergrande.
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Some say China would be compelled to step
in if the contagion was far reaching, like
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if there were multiple developers.
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But one company failing on its own, would
be unlikely.
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But wasn’t there a precedence for government
bailout for debt ridden companies in China?
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Yeah, we can take an example from Huarong
Asset Management.
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This was China's biggest bad debt manager
which secured a rescue package from some of
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the country's biggest financial firms.
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Its plight had become the biggest test in
decades of whether Beijing would shield state-owned
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firms from market forces amid a renewed push
by President Xi Jinping to rein in debt growth
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as defaults have hit records.
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So what we’re going to be watching out for
is whether President Xi will balance setting
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the precedent of a very expensive state organised
bailout, knowing that the government can't
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save all distressed developers.
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And not to mention, it doesn’t really jive
with his vision for common prosperity, and
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an equitable society, it has no room for rescuing
Hui Ka Yan, who at one point was China’s
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richest man.
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Emily, what is the biggest takeaway from this?
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You know, it touches so many people, it's
not just about an investment.
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Real estate makes up more than a quarter of
the Chinese economy.
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This is about people's housing, they're paying
mortgages for homes that have not even been
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delivered yet.
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People are just trying to build themselves a future.
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The story continues to unfold.
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Thanks everyone for watching this video,
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don't forget to subscribe
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and while you're at it, let us know what do you think
about China's real estate crisis. Stay safe.
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