Will Evergrande Collapse and What Is The Potential Impact On Australia
The Australian stock market had its worst day for the last 8 months on Monday (20/9/2021) amid fears of a Chinese real estate conglomerate collapsing—China Evergrande Group(“Evergrande”). Evergrande went from global titan to the world’s most indebted real estate developer, racking up a staggering $A432 billion in debt.
Some economists have warned that the collapse of Evergrande could become China’s “Lehman moment” — a reference to the bankruptcy of Lehman Brothers as a result of the subprime mortgage crisis, which triggered the 2008 global financial crisis.
Its shares plummeted by more than 10 per cent in trading in Hong Kong on Monday and is down more than 80 per cent in Hong Kong this year.
Why is it?
Until this year, Chinese property was booming, which drove the developers to get more leverage. Developers took out loan after loan from owes banks, shadow banks, other companies, investors, its suppliers, contractors, and home buyers. In addition, they leveraged up on high-yield US dollar bonds issued in the Hong Kong market, paying as much as 12 percent annual interest for access to overseas liquidity.
On the other side, President Xi said that China needed to “shift the focus to improving the quality and returns of economic growth … to pursuing genuine rather than inflated GDP growth.” The policy is to reform the debt-ridden behemoths of the Chinese economy.
China’s crackdown on property speculation is guided by the official mantra that “housing is for living, not for speculation.” Developers' woes began when strict rules on the real estate industry was announced last August. Known as the 'Three Red Lines' limit, the rules were aimed at deleveraging in real estate industry and making real estate more affordable for the average Chinese family, which severely limited their capacities to borrow.
The housing market is slowing down, which limit the developers’ capabilities to raise new money, either by issuing new bonds, or by borrowing from banks. Then developers even giant players like Evergrande will default on those maturing bonds.
What is the impact on Australia?
If it were to collapse, it would cause a significant drop in construction, meaning the demand for iron ore would fall, as would iron ore prices, given the AFR has estimated China’s construction industry accounts for about half of the steel used in the country. BHP Group is already down 30 per cent from its peak earlier this year as the price of its signature product, iron ore, has collapsed more than 60 per cent, albeit from record highs in just 3 months.
Australia might enjoy the opportunity to absorb the investments pulled back from China. Potential Evergrande collapse would cause negative impact on China’s property industry, significant investment would be retreated considering its great contribution to China’ economy. As a reference, Investors withdrew $US95.3 million from the Fidelity China High Yield fund in the week ended September 22, the biggest drawdown on records going back five years, and $US37.9 million from according the BlackRock Global Funds China Bond Fund, according to data from EPFR Global.
With triple A sovereign rating and stable credit market, Australia is advantageous to attract global investors who seek opportunities in Asia-pacific. Property accounts a significant portion in Australia’s economy, and it has proved its resistance in past 30 years. Despite mass job losses, widespread lockdowns, the shuttering of the economy and a resulting recession, and the disruption of trade, median housing values across Australia have surged 15.8 per cent over the first eight months of 2021, and are 18.4 per cent up over the past year. Global investors have poured a lot of investments and they may deploy more into Australia’s property industry to gain competitive return.
Is it possible to see a “Evergrande Collapse” in Australia’s Real Estate Industry?
No in simple words.
On macro level, the property is Australia’s biggest industry, which contributes 13% of Australian GDP, or $202.9 billion. The property industry is the biggest employer, who offers more than 1.4 million jobs, more than mining and manufacturing combined. Just as Mr. Morrison said, "Our economy needs the property industry to do well, particularly as we transition from the mining investment boom.” Australian governments at all levels are looking for ways to secure strong and consistent economic growth, that’s why they focus more on this industry to keep it healthy.
On a micro level, the leverages of Australia’s developers are quite rational.
The funding sources for developers are similar, namely equity and debt sectors. Typically, the debt tranches are in two parts, senior debt and junior debt or mezzanine debt.
Senior debt or first mortgage, which is the traditional form of funding, is provided by the major banks and their subsidiaries, or non-bank lenders which are more common recently.
The criteria to get a bank loan is becoming higher since the banks require significantly more equity, with average loan-to-value ratios (LVRs) around 50% to 60%. Besides, Banks may require pre-sell 80–100 per cent of the development in order for the bank to lend. Such pre-sales avoid a situation where the developer is unable to sell the development and pay off the debt.
In the non-bank space, although market share by non-bank lenders is trending upward, they were being extraordinarily cautious with investors’ money. The LVR they require is around 70%, and they keep closely monitoring the construction phase.
Developers might source mezzanine debt which is most likely from regional and foreign banks, mezzanine funds, investment banks and private equity. Usually, mezzanine is short term necessary to ‘plug a gap’ in project finances and only account a small portion of funding source.
Unlike developers in China, Australia’s developers are not active in open market. Most of the developers listed in Hong Kong Exchange focus on residential sectors. On the contrary, most of the listed developers in ASX focus on commercial sectors. Equity private placement, high-yield bond issuance and other capital raising solutions are not common in Australia.
Even the business model is quite different. To expand business, developers in China keep acquiring land reserves for future developments. This capital intense strategy imposes further capital requirement for the developers.
So, “Evergrande collapse” would bring some challenges to Australia, but it may also bring opportunities for Australia. Due to regulation and environment, we might not see a giant player like Evergrande in Australia, but we have less concerns on our real estate industry.
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