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Could the Evergrande Debt Crisis Lead To the Meltdown of the Worldwide Financial markets?

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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.

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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. 

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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. 

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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.

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