China Evergrande Group. If you haven’t heard of it, you should be aware of it. It is a major property developer in China, is battling to meet its debt obligations and may well be in default already.
Naturally, comparisons have been made with the failure of Lehman Brothers, as would any potential major corporate collapse.
Its share price has fallen over 80% so far this year. Prices of bonds have also dropped sharply.
Evergrande’s troubles have stemmed from a large debt burden combined with the Chinese government’s drive to curb property prices. As part of the curbs to the property sector, regulation dubbed “three red lines” was implemented which limited debt levels of property developers. Basically, real estate developers have been forced to deleverage at the same time as when curbs on property sales and mortgages have been imposed.
Evergrande has been busy attempting to offload its assets, but recently has run into trouble finding buyers. Last week, it was reported that Evergrande requested an extension on certain loan payments, and media reports indicated that it was suspending interest payments to two banks.
It isn’t a good sign when you can’t make interest payments, and no one will buy your assets. When there are investors protesting outside headquarters demanding their money back, it looks very much like a typical bank run. It is hard not to see an outcome involving either 1) a government-led bailout, 2) a write down of its debt, 3) a complete wind down of the company or 4) some combination of the above.
There is one key difference between Evergrande’s situation and the collapse of Lehman Brothers, and that is the ability of Chinese authorities to do something. Former US Federal Reserve Chairman Ben Bernanke later spoke publicly about the Fed not having the ability to prevent the failure of Lehman Brothers, even though he thought they should do “absolutely everything possible” to prevent its failure from occurring.
There are not the same limitations for Chinese authorities, but whether there is a willingness to help another story. Bailing out Evergrande runs completely counter to the initial message from the government campaign to reduce excessive house price gains and risk taking within the property sector.
However, there is the argument that the government will step in because the potential fallout would be too great. In other words, Evergrande could be a case of ‘too big to fail’. The company has over US$300 billion worth of liabilities and nearly $20 billion of US dollar-denominated bonds outstanding, over 70% of total bonds on issue.
No one really knows how big the contagion impact will be to the rest of the global financial system if Evergrande were allowed to fail. But that is the point — it could be bigger than most realise.
First in the firing line would be other indebted property developers, and their ability to renew their loans. It could severely limit the ability of other Chinese corporates to obtain debt financing, domestically and abroad. Further, there is the question of whether banks and other institutions in China and around the world can manage their exposure, not just to Evergrande, but to the Chinese property sector.
A possibility is an orderly debt restructure and winding down of the company, although that would still mean debt holders will still wear the burden of major losses.
The current value of bonds at below 30 cents in the dollar would suggest that a major write down or likelihood of default has already been factored in. So, the good news is that to date, there has been limited contagion impact.
Another difference between Lehman Brothers and Evergrande may be that Evergrande’s interconnectedness with the global financial system is not as large, although Evergrande will no doubt have big ramifications in China. But perhaps the biggest difference between Lehman Brothers and now, is that no one can say they didn’t see it coming.
Originally published at https://bitesizedeconomics.com.
