By Tony Jiao, Staff Writer
When Canadians think of housing, we often think of the ridiculous prices in Toronto, or Vancouver. While it is true Canada’s housing markets are a serious problem, they are not the only ones ballooning year after year. Asian markets, too, have seen astronomical gains over the last decade. For example, a high-end apartment in Beijing typically sells for USD $13,780 per square meter. Furthermore, these prices have consistently increased 5.3% year over year for the last decade, quickly pricing out young first-time buyers.
You could be fooled into thinking this is a booming market for any business to be in. However, this could not be further from the truth. Of the world’s 139 billion USD junk bond market, Chinese real estate companies alone are responsible for a staggering 46%. A junk bond, also known as a high-yield bond, is so named because of its inherent risk; the underlying company is very unlikely to deliver on its payments, thus buyers demand a higher interest rate, giving the bond its name. Typically, you would not find booming companies in the junk bond market. So why are Chinese developers, who charge such exorbitant prices for each of their homes, being forced to sell these bonds?
One recent example to illustrate the problem is Evergrande. Evergrande is the second-largest real estate developer in China, with about 2.3 trillion yuan ($360 billion USD) in assets. Unfortunately, it also holds 1.97 trillion yuan ($306 billion USD) in liabilities, primarily from its unfinished buildings and outstanding issued bonds. A quick look at Evergrande’s market performance q reveals that Evergrande is struggling badly. Shares in the company (3333. HK) have sunk more than 80% since the beginning of the year, costing the company more than $200 billion USD in market value. Meanwhile, yields on its bonds have skyrocketed from 13.7% to 636% in March, clearly indicating that investors are less than optimistic about its survival. To put it plainly, this business is on its deathbed.
Meanwhile, a Google search of the company’s name reveals even more problems. Every news article reports that on Sept 24th, Evergrande missed its first bond payment of $83.5 million USD, then the next one on Sept 30th. On Oct 21st, with just one day remaining before the company would formally enter default, they made the payment due Sept 24th, narrowly avoiding default. If a default should occur, lenders will take control of whatever financial assets Evergrande owes them. Unfortunately, most of these assets happen to be worthless husks of apartment buildings or equally worthless bonds. Essentially, their money will vanish.
While the default of some Chinese developers doesn’t seem like it’ll affect us back at home, there are serious consequences that could arise from a potential collapse of Evergrande. Many western financial firms, including Canada’s own RBC, hold a stake in Evergrande. In fact, some 171 Chinese banks and 121 other financial firms around the world have a stake in Evergrande’s debt. Should Evergrande default, a “credit crunch” could very well take place. During a credit crunch, banks that have recently taken large losses can’t afford to lend out as much money. Therefore, other businesses can’t afford to borrow money at an affordable rate, leading to less money being circulated in the economy, stagnating growth and triggering a recession.
So, with such dire consequences, will the Chinese government intervene? It doesn’t look likely. The Chinese government has instructed Hui Ka Yan, the company’s founder, to bail out his company using his own wealth. Meanwhile, officials have assured citizens that Evergrande is an outlier, and damage will be contained. However, one only has to look a little deeper to realize that this isn’t true. Many other smaller real estate companies in China have entered default in October alone. Sinic, a smaller developer, defaulted on $246 million USD bonds on Oct 19th. Modern Land also defaulted on Oct 26, on a $250 million bond. Whatever hope that Evergrande is not a symptom of a much larger problem is quickly fading away.
So what does this mean for Canadians? Will we see a repeat of the 2008 financial crisis? For now, it is too early to tell. However, actions by Chinese companies in the real estate sector, as well as the Chinese government, will be crucial in the coming months. With margin debt recording record highs around the globe, we truly cannot afford for Evergrande to become the domino that brings the world’s financial system crumbling down.