Friday, September 17, 2021
Chinese property developer Evergrande’s liquidity crisis has sparked fear and massive selling in Chinese property stocks over the past several weeks. The big question is could this be the first domino to fall, sparking a systemic risk scenario, similar to when Lehman Brothers went under 13 years ago this week? The good news is we don’t think so, but we’ll get to that later.
With more than $300 billion in liabilities and only $15 billion in cash on hand, Evergrande is currently the world’s most indebted real estate developer. Worries are mounting that starting next week it won’t be able to pay $84 billion of interest due (according to Bloomberg), along with potentially missing a principal payment on at least one of its loans.
With Evergrande’s share price down more than 80% this year, investors are clearly voting with their pocketbooks, while the chart below shows the pressure its dollar bonds have been under as well, at deeply distressed levels to the tune of 28 cents on the dollar recently.
Multiple downgrades have happened the past two weeks, and some rating agencies are noting that an outright default is probable. Should this happen, what could the fallout be? With 1,300 real estate projects in 280 cities in China, could China’s communist government intervene to avoid a messy default? So far that answer has been a resounding no, with the company instead looking to banks and other creditors to help the impact of a default.
The bad news keeps coming, as yesterday, Evergrande suspended trading of its onshore corporate bonds, after yet another downgrade, taking it one step closer to restructuring or default. So is Evergrande China’s version of Lehman Brothers? Here are three reasons we don’t think so.
- First, the dollar bonds will likely get restructured, but most of the debt is in global mutual funds, ETFs, and some Chinese companies and not banks or other important financial institutions. Remember, Lehman Brothers was held on nearly all other financial institutions’ books, so not nearly as many institutions will be impacted by this versus Lehman.
- Secondly, we think the odds do favor the Chinese communist government will get involved should there be a default. They are holding out as of now, but the fallout could be too great for them to avoid intervening.
- Finally, Evergrande has tangible assets that can be sold off to settle financial obligations. Their assets aren’t great and creditors know that the company is in financial trouble , so the value of its assets aren’t likely worth as much as they think but it will still help settle some debts. Remember, Lehman didn’t have hard assets it could sell off whereas Evergrande does.
“Although the impact from Evergrande’s liquidity crisis is enormous, the good news is the fallout hasn’t started to spillover to other markets,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Short-term funding markets are acting just fine in China thus far; remember, it was the money markets in the U.S. that first started to show cracks in the system in early 2008, well before the wheels fell off.”
As shown in the LPL Chart of the Day, China’s money markets aren’t showing any signs of systemic risk. These tend to be the canary in the coal mine, and the fallout appears to be fairly contained as of now.
LPL Research downgraded its view on emerging markets to negative from neutral last month, due to concerns over China’s regulatory crackdowns and heightened political risk. Now with Evergrande’s liquidity crisis in the mix, we continue to recommend an underweight to emerging markets in portfolios.
This is a very fluid situation and one that could clearly change on a dime. Although the Chinese communist government has avoided helping Evergrande so far, we think the odds do favor some type of eventual bailout to limit the ripple effect from a potential default. We will continue to watch the action in the short-term lending markets for clues if this is spiraling into something larger.
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