Introduction

The huge amount of debt hold by Evergrande, the Chinese real estate group, could lead to a credit crunch the like of which we have never seen. It could have implications for all financial markets especially crypto.

What the hell is going on!

We can not talk about Evergrande before we talk about the Chinese property bubble. This sector has provided for this company the ingredients to become a giant.

To say that the Chinese residential property market is a bubble is an underestimate. It has been so hot recently that online units sold out in minutes. In March, 288 apartments in Shenzhen sold out online in less than eight minutes.

People are legitimately willing to put down upward of 100000 dollars on the spot, just to have the opportunity to buy property two to three years from now. The main reason why such a demand on the property market, is that the housing market is seeing as one of the main forms of investment in the country.

When compared to the western counterpart, Chinese citizens own more property than they own bonds or stocks. In China, at least 96% of households owned at least one home, in the US, however, there is a 65% homeownership rate.

You love statistics, here is more. At the peak of the US property boom, $900 billion was being invested in residential real estate. While in China this year, almost $1.4 trillion was invested in housing. There was no such record registered worldwide before.

Buying a property in China is more about speculation than investing.

The believe that prices will always go up

Such a fulfilling prophecy, We have seen them on many occasions including the subprime mortgage crisis in 2009. And much like 2009, this property bubble was not built on saving, rather a huge amount of debt. 

The boom has taken dollar investment away from other industries competing with the real estates business

To get more close picture of how dangerous this debt fuel bubble is, here is one more statistic. According to the bank for international settlement data, the US accounted 19% increase in household borrowing back in 2009. In China, it is 57% over the decade through 2019.

Housing is for living in, and not for speculation

If the government would try to deflect the housing bubble and forbid massive insane speculation, Giving the fact that so many people have their net worth tied up to housing. The deflection could lead to social unrest.

The only solution, was to keep the property market to continue its growth just so long as it keeps the people happy. And happy they have been, until the first ingredient that drove the bubble is no longer there, And eventually the epic crush.

Evergrande

Introduction

Evergrande is one of the largest property developers in China. It was established in 1996 and has grown at a breakpoint ever since. Its founder, HUI KA YAN was the richest man in China as he steered Evergrande toward that Chinese property boom. 

To understand how big this firm is, they earn 1300 projects in over 280 cities across China, It is also a massive employer with 200000 staff and hires around 3.8 million people every year for project development from contractors to sub-contractors.

This firm has diversified also their business going from building electric cars to, beverage business. They bought a football team and intend to build a huge football stadium for their team. All this would look well and good if Evergrande would be able to fully funds this expansion, but the reality is that all this bulk of the growth has come thanks to a pile and pile of debt. 

Evergrande's total liabilities swell to over $300 Billion.

This debt burden has made Evergrande the most indebted property developer in the world, In their rapid expansion over the last few years, Evergrande has taken all forms of debt, from bank loans, Bonds, and dollar bonds. However, one of the most common forms of debt that Evergrande has taken were commercial papers, Which are simply an unsecured form of debt, used by Evergrande to honor their short terms financial obligations. 

In case of Evergrande. These commercial papers were issued to contractors or suppliers who worked on its projects, It was issued as a substitute to cash and was seen as secure. So secure that Evergrande contractors were to give the same papers to their suppliers as payment since they see it as legit. 

Evergrande has taken billions from several bank in China

Only last year, Evergrande reported total bank borrowings of around $107 billion including loans granted by trust firms rather than banks. 

With that being said, The firm has less bellow the line income to pay even the interest on their debt rather than the principle. This realization was highlighted by the firm itself, stating in public that, it may not be able to serve all of its debt. Banks in China started freezing Evergrande deposits to keep some collateral for paying back these loans. Of course, the international financial market has taken notice, with immediate debt restrictions. 

The markets have also reacted. The price of the bonds in circulation, hits 30 cents of a dollar, as well the shares have been on a sustained decline over the past few months with an 80% breakdown this year. 

The part that pushes Evergrande to the verge of a total collapse, is the fact that they have taken money in deposit from almost 1.5 million people. These people have injected funds into Evergrande homes that have yet to be built. 

Is Evergrande too big to fail

The idea that comes to mind is! If this company is so crucial to the Chinese real estate sector, Why the Chinese government doesn't bail it out. After all, they have the final say. 

Well, the Chinese government has come out previously with strict directives to limit debts, including those three main indexes: Cash on hand, Value of assets, Value of equity. They even instruct banks to restrict real estate landing to 40% of their total under the new rules that took effect recently, 

With that being said, the Chinese government wants to give an example to the other real estate developers, in order to make it clear that the rules applies even if a firm is on the verge of a total collapse. This means the collapse for Evergrande is not only likely, but it is inevitable, and it would be ugly. 

Domino effects

The real risk here is that this collapse would not only be contained in China, but spread to the rest of the world much of the 2008 credit crunch did. Let's dive into the Evergrande liabilities.

These firm liabilities extend to more than 128 banks and 121 non-banking institutions, according to the letter Evergrande sent to the government last year. Depending on how much exposure each of these counterparties have, there could come a situation where they would them selfs become too hot to touch. 

Selling assets

The fear of the collapse could spread to other indebted entities, such as banks. Who may feel concerned about their abilities to serve their debts. As a result, their commercial papers and bonds may become toxic. 

To ease its liquidity crunch, Evergrande may think about selling its assets which the majority are properties. It could lead to a worse scenario, where it will send all property developers to debt and hurt most of the Chinese savings who bet on the market. 

The collateral falls in value when there is more debt.

The impact on international market

Evergrande default would impact a lot the international market because there are lots of Evergrande debt holders. These include assets managers, international bonds funds, and other corporations such as the Ashmore group Plc who hold $400 million of Evergrande bonds, BlackRock Inc, and UBS Group.

With that being said, what happens if the contagion spreads to the rest of the Chinese, property developers, banks, and companies! in other words, what happens if these entities won't be able to honor their debt. Would it be an imminent threat to the world economy since the internationals market is tied up to the Chinese? Not to mention that these major economic players had publicly traded equity on the international market. Markets such as Shanghai stock exchanges. 

The default of Evergrande would extend to all markets including the crypto market.

Bitcoin as a risk on asset rather than a safe heaven

In a time of market stress, bitcoin acts as a risk-on asset rather than a safe haven. This means that investors would limit their exposure to the market uncertainty by selling their bitcoin holding. From the experience, we learned that bitcoin has a strong correlation with the equity market. 

Bitcoin is an asset that faces the same risk in a short term from the global financial contagion.

Tether

Consolidates reserve report

Evergrande default could expose Tether. For those who don't know Tether. It is the company behind the USDT stable coin which you would find an explicit explanation on intCount previous article. 

With that being said, the reserve held by this company to mint the USDT for crypto traders happens to be 50% in sort of commercial papers and certificate of deposit which is roughly $30 billion worth according to the breakdown of their reserve report published this year. The question here is, What if these papers and certificates belong to Evergrande!! 

Why Tether has so much commercial paper!

here are two answers to this question, the first one would be that Tether would like to earn interest on these commercial papers and the second would be that there are very few banks that would be willing to hold $30 billion in cash for Tether.

Does Tether holds any Evergrande commercial paper

When it comes to the ocean of commercial paper, no one knows. As these assets are not standardized like bonds. If it would be the case, the implications are immense. Because on a fist hand. It would mean that the reserves are not fully backed, and all that commercial paper would be worth a lot less.

Why Tether matter to financial market

Tether remains the major component for bitcoin liquidity. On many exchanges platform, USDT which is the coin issued by Tether, is the main pair to buy other crytpo. USDT by far, remains the highest coin by trading volume with a $56 billion per day. So, quite simply if there is a crisis confidence in Tether, this volume will dry up.

C/c

The goal of this article was to create awareness, rather than nothing else. The default of Evergrande still not immediately clear. It all will depends on wether the Chinese government will come to its aid or not.