The Emerald Bay residential project developed by China Evergrande in the Tuen Mun district of the New Territories in Hong Kong, China, on Friday, July 23, 2021.

Lam Yik | Bloomberg | Getty Images

Chinese real estate giant Evergrande is on the verge of collapse, and analysts warn that the potential impact could have far-reaching effects spreading outside China’s borders.

“The collapse of Evergrande would be the biggest test China’s financial system has been exposed to in years,” said Mark Williams, chief economist for Asia at Capital Economics.

Here’s how bad the problems are and what to expect for investors.

How did we get here?

After years of expanding rapidly and buying up assets in the wake of the boom in the Chinese economy, Evergrande is now snowed in with stifling debts of $ 300 billion.

The world’s most heavily indebted property developer has struggled to pay its suppliers and warned investors about default twice in so many weeks.

On Tuesday, Evergrande said its home sales are likely to continue to decline significantly in September after months of declines, making its cash flow situation even worse.

The Chinese developer is so large that the effects of potential failure could not only hurt the Chinese economy, but also spread to markets beyond.

The collapse of Evergrande would be the greatest test China’s financial system has been exposed to in years.

Mark Williams

Capital Economics, Chief Economist Asia

The banks have also reacted to the deteriorating cash flow. Some in Hong Kong, including HSBC and Standard Chartered, have declined to grant new loans to buyers of two unfinished housing projects in Evergrande, Reuters said.

Rating agencies have repeatedly downgraded the company citing its liquidity problems. Evergrande’s problems worsened last year when China introduced rules to curb developer borrowing costs. These measures limit a company’s debt in terms of cash flows, assets, and capital levels.

The share price has plummeted nearly 80% so far this year, and trading of its bonds has been repeatedly suspended by the Chinese stock exchanges in the past few weeks.

What is Evergrande doing?

Evergrande is everywhere. The main business is in real estate and is the second largest real estate developer in China by revenue.

  • Evergrande owns more than 1,300 real estate projects in over 280 cities in China.
  • Property Services Management is involved in nearly 2,800 projects in more than 310 cities in China.
  • The company has seven units that serve a variety of industries including electric vehicles, healthcare services, consumer products, video and television production units, and even a theme park.
  • The company claims it has 200,000 employees, but indirectly creates more than 3.8 million jobs every year, according to its website.
  • Evergrande stocks and bonds are featured in indices across Asia.

Who will be affected?

Those affected include banks, suppliers, home buyers and investors.

Evergrande warned this week that its escalating problems could lead to wider risk of default.

It said that failure to repay its debts can lead to a “cross-default” situation – where a default triggered in one situation can spill over to other obligations, leading to wider contagion.

Bankruptcy sparked by the collapse of large property developers was the most likely scenario that could lead to a hard landing in China.

Mark Williams

Capital Economics, Chief Economist Asia

1. Banks

The banking industry would be among the first to be affected if there were any contagion effects on the wider real estate sector in China, said Williams of Capital Economics.

“Bankruptcy triggered by the collapse of major developers was the most likely scenario that could lead to a hard landing in China. Williams wrote in a note last week.

2. Home buyers and investors

Protests by angry homebuyers and investors have broken out in some cities in recent days, with social unrest among the concerns.

Around 100 investors showed up at the Evergrande headquarters in Shenzhen on Monday and demanded the repayment of loans for overdue financial products – according to Reuters, chaotic scenes formed.

Read more about China from CNBC Pro

In fact, sentiment is already spreading to Asian high yield bonds. Yields on Asian offshore bonds, which are dominated by real estate companies, have risen to an average of 13%, according to TS Lombard.

That also means offshore investors are on the losing side, the research firm said in a statement last week.

“The company’s guarantee to deliver all pre-sold projects is likely to result in seeing little, if any, overseas stakeholders in the event of a bailout from the final sale of a developer’s assets,” said TS Lombard.

“Hence the prospect of an unequal swap that will protect the interests of onshore lenders – households and banks – at the expense of equity and offshore bondholders,” the press release said.

3. Suppliers

The aftermath of Evergrande’s failure could also affect other industries if suppliers are not paid. According to S&P Global Ratings, Evergrande could “persuade” its suppliers and contractors to accept physical real estate as payment – to get cash to repay loans.

I believe there will be some supportive action from the central government or even the central bank to save Evergrande.

Dan Wang |

Economist, Hang Seng Bank

In an August report, S&P estimated Evergrande to pay over 240 billion yuan ($ 37.16 billion) of contractor bills and payables over the next 12 months – approximately 100 billion yuan of that amount is in due this year.

A paint supplier to Evergrande, Shanghai-listed Skshu Paint, said in a file that the real estate company had paid back part of its real estate debt – and unfinished, too.

Rating agency Fitch said banks could also be indirectly exposed to Evergrande’s suppliers – the developer’s trade payables were 667 billion Chinese yuan, according to Fitch analysis.

Is Evergrande Too Big To Fail?

The government is likely to step in, according to analysts, given Evergrande is so important.

“Evergrande is such an important real estate developer and it would send a strong signal if something should happen to him,” said Dan Wang, an economist at Hang Seng Bank. “I believe there will be some supportive action from the central government or even the central bank to save Evergrande.”

But restructuring may be more likely, according to other analysts.

“The most likely endgame now is a managed restructuring where other developers take over Evergrande’s unfinished projects in exchange for a stake in its land bank,” Capital Economics’ Williams said in a note last week.

It is likely that the government will give homebuyers and banks priority over other parties, he said.

“The main priority of the policy would be households that have made deposits on unfinished real estate. The company’s other creditors would suffer,” Williams wrote.

Investment bank Natixis said the Chinese government will avoid “systemic risk” in the run-up to the Chinese Communist Party’s National Congress in 2022, given its historic importance.

“However, it would also mean that China Evergrande’s debt crisis could emerge on the streets,” the bank said in a statement, adding that economic growth will not offset financial losses as it has in the past.