What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing in today's video we're going to go over the currently unfolding collapse of evergrand group, which is the second largest property developer in china, with trillions of yuan's Worth of assets and liabilities, they have over 300 billion dollars worth of liabilities and as soon as this coming week, they'll be likely to default as they have insufficient cash to make interest payments. It's hard to overstate how disastrous an ever grand default could be to the chinese economy. The real estate sector accounts for roughly 20 of the country's gdp currency controls make it difficult to invest in the stock market, so many individuals turn to real estate as an alternative. This has led to property price bubbles in many chinese cities with people often buying unfinished properties that sit empty for years, while they wait for the prices to rise.

Evergrand is in the business of funding residential property developments and selling them to individuals both as personal residences and investments. They benefited tremendously. As the real estate bubble was inflating. They borrowed hundreds of billions of dollars to fund new real estate developments.

They were able to sell these properties for high prices, allowing them to book massive profits. Their stock price increased five-fold in 2017, giving them a market cap in excess of 300 billion hong kong dollars. Unfortunately, their profitability was built on top of the house of cards which is now starting to crumble. Down, evergrand has hundreds of predators and thousands of suppliers.

An unorganized default would be analogous to a domino effect causing a wave of defaults across the chinese financial system. In a worst case scenario, it could have an effect similar to the default of lehman brothers in 2008. In this video we'll go over, what exactly evergrand does how they came to their current precarious financial position and what impacts it will have on the chinese economy. Evergrand was founded in 1997 by xiujian throughout the 2000s, the business grew rapidly as a chinese real estate market developed.

They build large, real estate development projects and sell the properties to end consumers. These projects require significant upfront investment, so the only way to grow fast is by taking on a lot of debt. They fund them with a combination of their own cash on hand, down payments from end customers and a lot of debt. In 2009.

They ipo'd on the hong kong stock exchange raising 700 million dollars, which they used to invest in new growth initiatives. By this point, evergrand was already one of the biggest property developers in china and shu was already a billionaire, but his ambitions were far from over. They expanded into businesses outside of real estate, including the guangzhou evergrand football team, an electric vehicle unit and an asset management and life insurance business. They even started a mineral water business.

Throughout the 2010s, the business became more and more bloated with their assets and liabilities exploding. To trillions of chinese yuan, but as long as the real estate market was inflating, their highly profitable development projects were more than enough to support their liabilities and their expansion into other ventures didn't slow down their core real estate business at all. They are currently working on a 24 billion artificial island called ocean flower island off the coast of china. In late 2020, the chinese government started getting concerned about a potential real estate bubble.

They enacted new regulations on how much debt property developers are allowed to take on. This was intended to reduce leverage in the real estate sector and prevent the bubble from growing out of control. But by this point it was already too late in order to comply with these rules. Evergrand was forced to fire, sell existing properties at heavily discounted prices.

In december, the government also limited the amount of money that banks were allowed to lend to property developers. This made it harder for them to roll over their debt to later maturities, given how much debt they have. Even small losses on property sales can cause a liquidity crisis by the summer of 2021. They started having trouble paying construction contractors who work on their developments.

Evergrand pays construction companies with so-called commercial paper. They basically give an iou saying that they will pay a certain cash amount at a later date. If their pace of new property sales slows down even little, they won't be able to make good on many of these ious. Remember that evergrand collects a down payment from consumers at the beginning of the project, and the new homeowner has to wait a few years for the property to be complete.

If evergrand goes bankrupt before the project is complete, the home buyer may be left holding the bag. Starting in the beginning of the summer, the company's precarious financial situation became a major topic in chinese media. This made prospective homebuyers, understandably hesitant to make down payments for evergrand properties. In july, new property sale contracts fell almost 40 from the prior month to 43 billion yuan.

In august it declined another 13 with sales falling. They had no way to make good on their commercial paper obligations to their construction contractors. They started getting sued by these contractors for failing to make payments on time. This caused a vicious cycle with their financial problems caused negative media attention, which in turn decreases sales making their financial situation even worse.

On september 15th, chinese authorities warned banks that evergren would not be able to make its scheduled interest payments with no cash left. They are frantically scrambling to stay afloat. They started offering partially finished and unfinished properties to contractors in lieu of cash payments to the extent that any of them accept these, it will likely be at a steep discount to evergrand's development cost and further exacerbate their solvency issues. Evergrand also has a wealth management business which sells insurance policies and other financial products to individual investors.

They lacked the cash to make contractually obligated payments and defaulted on many of these products. Understandably, angry investors started staging protests at the company's headquarters, demanding their money back. They started offering partially finished properties to these individuals in lieu of cash at discounts of up to 50 percent in a desperate attempt to raise cash. They also tried to sell some of their subsidiaries, such as their electric vehicle unit, but since these subsidiaries rely on evergrand for financing, they have not been able to find any buyers for these assets.

At this point, a bankruptcy, or at least a serious restructuring, is all but guaranteed. The common equity holders will probably be wiped out. This is reflected in the stock price, which has declined more than 80 since the beginning of the year. Their bonds also now trade for pennies on the dollar evergrand directly employs 200 000 people, including construction workers who work for their contractors.

They indirectly employ 3.8 million people, given the size of their liabilities. If they default, many of their creditors would probably also go bankrupt. This could cause a widespread freeze up in the financial system and cut off liquidity to other property developers. Remember that the real estate sector makes up 20 of the chinese economy.

A credit crunch could put tens of millions of construction jobs at risk and plunge the country into a deep recession. Of course, the chinese government will do everything in their power to prevent this from happening. The most likely scenario is probably a bailout organized by the country's state-owned banks in any potential bailout. Consumers will likely be given first priority.

This includes people who bought evergren's wealth management products or made down payments for evergrand properties. Next, in line will be the construction contractors and domestic creditors holders of the common equity will be last in line in any restructuring. The common equity will probably be diluted to the point that it's almost worthless. There could be a situation similar to aig after the financial crisis, even though aig's business has recovered to a great extent.

Over the past decade, their equity was diluted to such a great extent in the bailout that shareholders who bought in 2007 are still down 95 percent. The government has sufficient resources to bail out evergreen and prevent a financial crisis in the short term, but this situation is emblematic of china's over leveraged corporate sector. Over the past decade, corporations have taken on large debt loads to invest in the growing economy. According to data compiled by yitai global, the country's total debt is in excess of 250 percent of gdp.

In the case of evergreen, the government's recent regulations were the straw that broke the camel's back, but their leverage was so high that a collapse probably would have happened on its own. Sooner or later, the government's recent restrictions around property developer leverage ratios may be enough to cool down excesses in the real estate sector and prevent more serious financial crises in the future. But the rapid and spectacular meltdown of evergrant shows that there are serious risks on the horizon. Alright, that wraps it up for this video.

What do you think about the evergrand situation? Let us know in the comments section below, if you enjoyed this content, make sure to hit the like button and subscribe. So you don't miss future uploads as always. Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.