The big business news story of the last two weeks involves a Chinese company called Evergrande. In the last two weeks Evergrande has failed to make two international debt payments and one local Chinese debt payment. We are going to talk about what that means in this video. WATCH NOW
A couple of things to start out. In this video I will say a few things that will be critical about China. It is important to say, please do not spread any hate to the Chinese people or the Chinese culture. My comments are directed at the failures of the government: The CCP or the Chinese Communist Party.
Also, I will be talking about investments. If you use any of this information to make investment decisions, you do so at your own risk. Investing is risky and you should discuss your investments with a finance professional.
Let’s get started with what you are here for… to find out what is happening with Evergrande. Let us do a quick recap.
Two weeks ago on Thurs Sep 23, 2021, Evergrande missed a debt payment of $83M. Last week on Sep 29, 2021, Evergrande missed a second debt payment of $47.5M. A missed payment is not technically a default unless it is made within 30 days. But two missed payments in a row is not a good sign. What a lot of people are not talking about is that Evergrande missed a third payment three days ago on Sep 30 to local Chinese investors. For this payment, Evergrande only made a 10% repayment.
The reason this is so shocking is that Evergrande is such a large and successful company. Here are some facts about Evergrande:
- Second largest property developer in China by sales
- Owns 1,300 real estate projects in China
- 12M people live in properties built by Evergrande
- Manages enough land to cover the size of Manhattan
- Indirectly responsible for 3.8 million jobs (or all of Los Angeles)
This is an enormous company. So, the fact that they missed a debt payment is shocking. It would be like in America, if you were to loan money to a major corporation like Amazon, you would expect them to be able to pay you back. So, all these people gave Evergrande money, and as of last week, the company is just not paying people back.
Unfortunately, Evergrande has more debt than any company in the world. Evergrande has $305B of debt. Just to put this in perspective, that is more than the entire GDP of New Zealand ($212.5B). In fact, Evergrande’s debt is 2% of China’s GDP.
Why should you care about Evergrande defaulting on its debt? People are so worried because they see this event as the tip of the iceberg. Evergrande itself is a problem because it is so massive, but if Evergrande is this bad, how many other real estate companies in China are also in trouble? People have reported about China’s real estate bubble for years. There are entire cities that have been built in China called “Ghost cities” that are sitting empty. Chinese companies are building apartments for the sake of building apartments with no one living there. Evergrande’s default could be the start of a market correction, and anyone holding debt to pay for those empty apartments is going to lose their investment.
Many of you know, this is something we have seen before. It just happened in the United States in 2008. We know what happens. In 2008, people were getting sub-prime mortgages for second homes where nobody lived. The market crashed. People never paid their debts. Banks started going under. Ultimately, the taxpayers had to bail out the rich people on Wall Street. And the rest of the poor people had to suffer through a horrible recession. The same thing is happening right now in China, but a whole lot worse.
Let us look at these three missed Evergrande payments to see how bad this situation is. I think what a lot of Americans do not understand is that debt in China is different than debt in the United States. In the US, if you loan a company money and they default, there is a fair legal process called bankruptcy. The company gets liquidated and all the cash that is left is distributed equally to all the debt holders. So you might receive $0.30 on the dollar. That means if you had loaned the company $100, you would receive back $30. That is not what happens in China. In China, the government decides who gets paid back. So if you had loaned Evergrande $100, you might be getting $0 back depending on if you have good connections with the Chinese Communist Party.
So if we look at the debt payments of Evergrande, the first two payments they missed were in dollars, which typically means they were owed to American banks. The third payment was to local Chinese investors, and Evergrande only made 10% of the payment. This shows that any payments due to international banks they are paying nothing, and they are trying to pay back the local Chinese investors instead. That should be concerning to foreign investors by itself. But what is even more shocking is they were only able to pay 10% to their priority investors. That is all the money they had. There are more debt payments coming due, and they have no money. That is how we know this situation is so bad.
Now last week, the European Central Bank President Christine Lagarde made a press statement saying that the impact from an Evergrande default would be limited. Jerome Powell, the Chair of the US Federal Reserve also came out and said that there was not a lot of exposure to the risk in the US. But here is the problem. The central banks have no idea what is going on. They cannot tell how much American banks have directly loaned these Chinese companies. They do not have access to that information. They do not know if American banks are ready to absorb the losses if they are not paid back. They do not know if the insurance companies are going to go under, if the loans end up being bad, just like what happened in 2008. They have no clue what is going on. They have their own agenda which is to calm people down. So of course they are going to come out and tell people there is nothing to worry about. When actually, you need to be prepared for what is happening.
Bloomberg reported last week, information on just a few of the international banks that have exposure to Evergrande’s debt.
- Ashmore Group $433M
- BlackRock $397M
- UBS Group $275M
- HSBC Holdings $207M
- Royal Bank of Canada $118M
What happens if these companies get zero dollars back? And this is just what has been publicly disclosed. There is a whole lot more lending out there that we do not know about.
The main issue is going to be whether US banks adequately prepared for default. Evergrande bonds were always junk bonds. If we look at Fitch ratings they had Evergrande rated at B on June 22, 2021, downgraded to CCC+ on Jul 28, 2021, downgraded to CC on Sep 7, 2021, downgraded to C last week on Sep 28, 2021. So even back in June, a B rating is a junk bond. Whenever a bank invests in junk bonds they should be prepared for some of them to go bad. But the question is, how prepared are they? This is a big change within a couple of months, and we do not know how many other bad Chinese companies are out there. How many of these Chinese bonds can the banks afford to not get anything back on their investment before the banks themselves go bankrupt?
One thing the US banks have always counted on is that the Chinese government is going to bail these companies out. This is a huge mistake. The Chinese government does not care if US banks get paid back. In fact, they would probably be happy to see US banks fail. We have already seen that Evergrande is paying back its Chinese investors and paying the foreign investors nothing. It would not even be politically possible for the Chinese government to bail out US banks. The Chinese people would not stand for that. Here in the US, we would not stand for that either. When we had our housing crisis, Americans hated bailing out the banks, but at least they were US banks. Can you imagine if the US bail out was for foreign companies? We would not have stood for it, and China is not going to do that either. I am hoping that US banks are preparing for the worst.
What actually needs to happen here, is we need to get real about why we are in this situation in the first place. Evergrande lied on their financial statements. When any company issues a bond, they have a financial plan on how they are going to pay back that bond. For Evergrande to miss their last three debt payments this badly means they lied about something in those financial statements. Where is the money? There was supposed to be money to make those payments. Where is it? When you lie on financial statements about bonds that means that someone is not going to get paid. And this is a problem that we see over and over again with Chinese companies. A lot of Chinese companies have lied on their financial statements, and a lot of US investors have gotten hurt. Recently the SEC has been cracking down with additional regulations against Chinese companies, with the main complaint being that accounting for Chinese companies is not accurate. The real story here is not that these are bad companies. These companies lie because the Chinese Communist Party pressures them to lie. Specifically with real estate companies like Evergrande, it is more important to hit the government’s growth numbers than to have accurate accounting numbers. The result of this is that people are not getting paid.
If you can tell, I am starting to get frustrated. Why is no one holding China accountable? Why aren’t are leaders calling China out on their actions? It is not just the companies that lie. The Chinese Communist Party is lying about what is going on. You cannot trust the statistics out of China. They manipulate their currency. They lie about their horrible record on human rights. They cover up their lies with propaganda they put on TikTok which is also a Chinese company. All of these lies are hurting the rest of the world and no one is holding them accountable. The Chinese Communist Party is screwing up, but unfortunately, it is a one-party political system, so the Chinese people cannot even vote their leaders out.
And this brings us to COVID-19. The CCP lied about that too. The big discussion right now is whether the COVID-19 pandemic started in China’s Coronavirus lab in Wuhan. I think we are never going to find out the answer to this question, because too much time has passed. But the question we should be asking is who in China lied to the world when the outbreak happened. When China started to lock down their own cities, at the same time they allowed people to leave on international flights all over the world spreading the virus. That was a human decision. They knew what was going on. Someone in the Chinese Communist Party made that decision, and it was probably someone at the top. They decided to protect their own people, and at the same time infect the rest of the world. That is the lie. How many people around the world have died because of that lie? Who is holding China accountable for that lie? How much money has it cost the US to fight the pandemic? Why isn’t China paying for that? In fact, the opposite is happening, because Evergrande has lied, and skipped out on their bond payments, and the US has to pay once again.
In essence, what has happened is that US banks have given China free skyscrapers. We loaned them the money, and the Chinese companies said, “Thank you for the skyscrapers. We are not going to pay you back.” They just got free skyscrapers. If these US banks wanted to build free skyscrapers, why didn’t they build them in the US. I would have liked some free skyscrapers in my city. Or if the banks wanted to invest in emerging markets, why didn’t they invest in Brazil or India, or someplace with a democracy where you would have gotten a chance of getting some of your money back.
I want to end with a main point here. Accounting is about the truth. Numbers don’t lie. And when you are lending people money you should expect honesty. And if people are not being honest, we should hold them accountable. This situation with Evergrande is about more than this one company. It is an industry wide problem in China. How many of these companies are being dishonest? How can we do business with these companies with the Chinese Communist Party is being dishonest? Those are the problems we have to start holding people accountable for, or the problems are just going to get worse. We keep getting hurt because no one stands up and says “You lied, and what you are doing is wrong.”
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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.
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