China’s Evergrande: Cloudy With a Chance of Default

Is it all but inevitable that China Evergrande Group will fall into the abyss and default on its more than $300 billion in obligations? Despite reports of lifelines and investments, nothing indicates that the real estate developer could successfully grapple with its pecuniary troubles that are still sending shockwaves across global financial markets. In recent weeks, there have been tremors in Beijing and the rest of the world. But when will the big one strike and trigger a hypercane on the planet?

A Default is ‘Imminent’

For the third time in a month, the property juggernaut missed interest payments on bonds totaling $148 million. In addition, Evergrande bondholders stated that they did not receive the coupon payments scheduled for Oct. 11. While the cash-strapped company has failed to address the non-payments, the latest news has amplified concerns that offshore investors will incur immense losses at the end of the 30-day grace periods for these coupons.

What is worse is that this could be growing evidence that Evergrande is on the brink of slipping off the fiscal cliff. Creditors are already ringing alarm bells that it is only a matter of time before it defaults on its debts. The final nail in Evergrande's coffin might happen next week, when it faces another $150 million in offshore payment obligations.

Still, despite the bearish and defeatist sentiment throughout the financial markets, bondholders are pleading for "constructive" engagement with the top-selling property developer. Some bondholders have enlisted investment bank Moelis & Co and law firm Kirkland & Ellis for help. Bert Grisel, a Hong Kong-based managing director at Moelis, conceded on a conference call with bondholders that "an imminent default" could transpire shortly. Grisel added that the firm has communicated with many advisers, but there has not been any "meaningful dialogue with the company or provision of information."

At this point, the only way Evergrande will be resuscitated is if the reports of Hopson Development acquiring a 51% stake – worth $5.1 billion – in the company come true. Shares in these firms have been suspended, so both sides could still be engaged in serious discussions. But, if talks fall through, is a “Lehman moment” all but certain? If so, this could manufacture a ripple effect through the globe, thanks to its more than 1,300 properties and 200,000 employees (or indirect support of 3.8 million jobs).

Did Anyone See the Signs?

Ren Zeping is China Evergrande Group’s former chief economist, a post for which he earned $2.3 million a year. According to a post on his WeChat account, Zeping was ignored when he warned about the dangers of debt-fueled growth. Ren wrote:

"I was criticised publicly, for a rather long time, at a top management meeting. I was told that I am not looking at the situation from a broader view and not getting a thorough understanding of the company’s major strategy. Many of the employees know about this. It was such a huge frustration and heavy blow for me, [as someone] who was new to the company and [who had] planned to help the company better develop.”

He is now the chief economist at Soochow Securities.

What Now?

But if the collapse of Evergrande is a systemic risk for China, will it also be a disaster for U.S. markets? At first, it might be easy to dismiss the real estate titan presenting a clear and present danger to the United States economy and financial system. However, because Corporate America relies on Beijing for growth, this could have devastating consequences, especially if its drop initiates a recession for the world's second-largest economy.

If the real estate market contracts, companies like metals and mining giant Freeport McMoRan and construction juggernaut Caterpillar would feel the pain. If people lose their jobs, companies that have made tremendous strides in China, such as Starbucks, Apple, and Estee Lauder, would likely see a decrease in revenues.

Still, some do not think it will result in substantial damage for America. CNBC host Jim Cramer recently stated on his program Mad Money:

"The bottom line? I don’t think the Evergrande fiasco will do serious damage to the U.S. economy, even as there are some groups that could get hit, but it does give investors a great excuse to do some selling. Just sit this one out please, then you can buy stocks with zero China connection at better prices and not have to worry about a place you had never heard of until today called Evergrande.”

It’s Not All Bad News

At least it is not all terrible news for Evergrande. The electric vehicle unit of the corporation, Evergrande New Energy Vehicle Group, announced that it plans to release electric cars from the production line next year. Business leaders spoke with suppliers and local government officials in Tianjin and vowed to move ahead with its Hengchi-branded cars. The problem? It has yet to deliver a single vehicle to customers. But this may not matter when the Tianjin government says it will coordinate with financial institutions to lift Evergrande and assist in its goal of accomplishing mass production.

The End Is Near?

The only thing the world can do is adopt a wait-and-see approach to the Evergrande situation. Until the property giant can confirm an enormous bailout or buyout and eradicate its debts, onshore and offshore investors will need to mirror the line from Jerry Maguire and shout, "Show me the money!” After years of irrational exuberance in China’s real estate sector, the question now is: Who’s next to implode?

~ Read more from Andrew Moran.