Is Evergrande China’s Lehman Brothers?Hamish Risk | September 20, 2021
In this week’s Macro Briefing we focus on the rapidly evolving events around the Chinese property development company, Evergrande, which according to multiple reports is on the verge of collapse. This won’t come as a major surprise, the day of reckoning has been bubbling away for quite a few years now, but it is only just come to a head and is roiling markets globally. The assumption often made in the past was that it was ”too big to fail” and that the Chinese government would bail it out. Much has changed in terms of policy priorities in recent times and there’s now a growing belief that authorities could let China’s second-biggest property developer fall. This has led to numerous analysts and commentators calling this eventuality, China’s ‘Lehman moment’. Today we bring together a collection of pieces from analysts who follow China’s macro economy day in and day out, and who in most cases are all on the ground in China. They all argue that this IS NOT a Lehman moment, indeed, as one analyst suggests, this could well be a ‘Whatever it takes’ European moment instead. Should you be interested in speaking to any of the featured analysts, please get in touch.
China Evergrande real estate Eurizon SLJ Research
1. Why Evergrande isn’t China’s ‘Lehman Moment’
Unlike Lehman Brothers and other shocks, writes Stephen Jen from Eurizon SLJ Research, this crisis was mostly induced by government regulatory measures, and thus the emergency was in part intentional on the part of Beijing to shake up the property sector, and in particular the ‘three red lines’ policy introduced in 2020. Could Beijing have overdone this? Jen says this is a reasonable question to debate, but he thinks investors need to understand that most of what is happening in China is the intended outcome of Beijing. The other point that Jen makes is the Evergrande is still solvent. He says Evergrande’s liabilities-to-assets ratio is 0.83, i.e., it is solvent. The nominal value of the liabilities don’t change, however, the asset value could fluctuate, depending on market sentiment. That remains something of a risk. Therefore, how Evergrande can be successfully quarantined is critical. Jen says one only has to look at China’s zero-Covid policy and their zero-contagion policies in dealing with pressures in the debt market in the past to see the likely path forward. China will not tolerate a ‘debt pandemic’ and Evergrande will likely be ‘quarantined’ to infect only the weak property developers and not the market at large. Investors understand this, even though there are noises and angst on Evergrande. In general, global equities have been stable and EM has performed fine. These are the two dogs that haven’t barked, because if Evergrande were really the ‘Lehman Moment’ as some foreign analysts have suggested, these dogs would have gone mad by now, concludes Jen.
China banks China real estate Evergrande Plenum
2. Evergrande Is Not Lehman
The Chinese government’s top priority is to ensure Evergrande apartments are built and delivered, therefore minimize the risk of social instability, writes Chen Long from Plenum. But it is highly doubtful that the developer can get the buildings finished, he adds. Essentially none of the contractors have been getting paid, and as a consequence have downed tools. So what’s the solution? In this report, Long sets out a range of scenarios and options that could reduce disruption of deliver on the projects. These include, 1) local governments stepping in and work with construction firms directly by channeling all the mortgage money from the bank custodian accounts to their accounts, 2) brokering deals between Evergrande and other developers, letting stronger players take over and build the apartments, 3) To let Evergrande sell projects individually or in groups. As for the financial risks, Long says they are manageable because domestic banks’ exposure is limited, and China handled bank failures before, while offshore creditors will have no priority. They will be scorched for sure. Long expects that once Evergrande falls, Beijing will likely adjust property policies, making it “whatever it takes” Draghi moment rather than a “Lehman moment.”
China real estate Evergrande Trivium China
3. Evergrande: No bailout, but government help will limit economic fallout
A bailout of Evergrande is unlikely. The developer isn’t a systemic threat to the financial system, with most bank loans to developers heavily collateralized, writes Trivium China. Despite Evergrande’s size, a default will cause only minimal disruption to the financial system, credit markets, and broader economy, they argue in a note, published Sept 17. This will require extensive involvement of local authorities to guide Evergrande’s restructuring and deploy funds where necessary to maintain work on projects. However, Trivium’s relatively benign outlook comes with the caveat that a default might impact consumer psychology in such a way that homebuyers become increasingly unwilling to prepay for housing. If that occurs, then an Evergrande default might weaken funding conditions for other developers, sowing the seeds for further defaults.
China China banks Evergrande Capital Economics
4. Gauging the scale of Evergrande credit risks
Julian Evans-Pritchard at Capital Economics thinks if Chinese property developer Evergrande collapses policymakers will seek to protect homebuyers but allow other creditors to take losses. In his latest note, he looks to estimate how large the hit might be. Evans Pritchard estimates the onshore portion of the debt is equivalent to one percent of commercial banks’ tier 1 capital ratio. So, he says, in the event of a complete write off with all the losses flowing to the banks, average tier 1 capital ratios would fall from 11.9% to 10.9%, still well above the regulatory minimum of 9.5%. However, Evan-Pritchard notes any losses are unlikely to be evenly distributed and banks vary in their ability to absorb them. Thus, he says he wouldn’t be surprised if individual banks run into problems due to their exposure to Evergrande, but as long as the PBOC steps in to prevent a liquidity squeeze in the interbank market then the financial system as a whole appears to be in a strong enough position to absorb an Evergrande collapse.
China economy monetary policy PBoC Pantheon Macro
5. Will the PBoC Waver from its Early Normalisation Path as Evergrande moves towards end game?
Fear of Evergrande contagion is dragging the PBoC into liquidity injections and an RRR cut is in the offing, writes Freya Beamish from Pantheon Macro. She notes that The PBoC has already made an outsized injection of RMB 100B through seven and 14-day reverse repos on Friday, breaking with the recent norm of RMB 10B injections. Indeed, the Bank has made a series of ad hoc larger injections in the second half, showing an increasing trend. This increases her conviction that the Bank will need to offer a more permanent solution in the near future. Beamish thinks they will follow up with a 50 basis point Reserve Requirement Ratio cut, as soon as this month, but here are a whole host of other monetary policy tools likely to be employed, which Beamish covers in some detail in this note.