Understand the Evergrande crisis and its downgrade by Fitch

Two Chinese real estate developers, including the giant Evergrande, have defaulted on loans totaling $1.6 billion (BRL 8.9 billion), the credit rating agency Fitch said on Thursday.

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What’s up with Evergrande?

The group, with a debt of about $300 billion (BRL 1.6 trillion), has been struggling for several months to meet interest payments and apartment deliveries.

The cause: a regulatory change enacted last year by Beijing in the real estate sector to reduce borrowing and therefore debt. Since then, Evergrande has found itself illiquid.

Large and sometimes risky investments — tourism, leisure, digital, electric car — also explain the precarious situation of Evergrande.

On November 6th, the group was supposed to have paid a refund of US$82.5m (R$460.1m). It had a one-month grace period, which ended on Tuesday.

Since then, “no announcement has been made by the company or its creditors regarding the repayment,” Fitch reported on Thursday (9).

As a result, the agency downgraded Evergrande’s rating one notch, to the penultimate level of its nomenclature.

What are the consequences?

Evergrande says it employs 200,000 people and indirectly affects 3.8 million jobs in China. Its bankruptcy, therefore, would have catastrophic consequences for the Chinese economy, but also on a social level, with the risk of unrest.

Therefore, “the Chinese state is seriously involved in managing the situation”, stresses analyst Shehzad Qazi, from the China Beige Book office.

At the moment, however, Beijing is unwilling to reach into its pocket to save the group.

On the other hand, many assets will be sold to find liquidity, warns analyst Chen Long, from consultancy Trivium.

Communist power will lead to a “controlled dismantling” of Evergrande, Qazi believes.

What is the economic impact?

Real estate and construction account for more than a quarter of China’s GDP and act as a driving force for many other sectors, such as steel and furniture.

Evergrande’s setbacks have caused a crisis of confidence among potential buyers. In recent months, sales and property prices have dropped in many cities.

Most analysts, however, consider a “Lehman Brothers” scenario unlikely for Evergrande, as markets anticipated these difficulties.

The failure of the US investment bank in 2008 threw the planet into the worst financial crisis since 1929.

And the other developers?

In addition, there are difficulties in accessing credit. At least ten developers struggle or are unable to repay their loans.

Sunshine 100 failed to honor a payment of $170m (BRL948.1m) on Sunday (5), plus interest.

Kaisa, one of the most indebted real estate groups, should have paid 353 million euros (BRL 2.2 billion) on Tuesday (7). The company also “failed to pay” this refund, according to Fitch.

Of the $10.2 billion (BRL 56.8 billion) in foreign bonds not repaid this year by Chinese companies, 36% were for real estate companies, according to Bloomberg news agency.

Are there any precedents?

Evergrande’s situation is similar to that of the Chinese conglomerate HNA, a giant in tourism and aviation. Heavily indebted after acquisitions abroad, the private mastodon launched a bankruptcy process last January.

HNA owns an airline and was once one of China’s biggest employers. The court recently approved the division of the group into four entities, without this affecting the markets.