China Evergrande

by | 24 September 2021

  • China’s “three red lines” on financial thresholds were established to rein in indebted property developers.
  • China Evergrande Group is the most indebted.
  • Leading economic forecasting shops do not expect widespread contagion if the troubled Evergrande were to default or be broken up.
  • There is debate on whether this could be China’s “Lehman Brothers” event.
  • However, Evergrande’s total debt levels are roughly half of those of Lehman at the time of its bankruptcy.

China Evergrande Group has recently been making headlines and roiling markets across the globe. Its high levels of debt (north of $300 billion) and high interest rates, along with slowing demand for housing in China, have sent its shares plummeting. In 2020 the Chinese government created the “three red lines” of debt metrics developers needed in order to borrow more capital. They include a 70% cap on liabilities to assets, a cap of 100% of net debt to equity, and a cash-to-short-term-borrow ratio of one or greater. Evergrande has crossed those red lines.

As Evergrande’s stock price fell and bond yields blew out, fears of a wider contagion sent global stock markets down (temporarily). Numerous comparisons to Lehman Brothers surfaced. While Lehman wasn’t the first sign of stress in the subprime mortgage market (Bear Stearns had been sold prior to Lehman’s bankruptcy, and New Century Financial had gone bankrupt in early 2007), it marked a turning point in what became the Global Financial Crisis (GFC). Lehman is still the largest bankruptcy in U.S. history, with a debt load in September 2008 north of $600 billion, double that of Evergrande. Lehman’s bankruptcy sent the market into a tailspin, resulting in numerous bailouts and government intervention to prevent a complete collapse of the financial system.

Is Evergrande on that scale? Some say that this is a sign of the impending challenge of reorganizing China’s economy from a production-based growth engine to a service-based one. China is going through a deleveraging, which can be painful, as we saw across multiple countries after the GFC. Development makes up a sizeable portion of China’s GDP, estimated at 20%–30%. If other developers are brought down, this might affect China’s growth, and in turn, GDP across the globe.

However, major economic forecasting shops do not expect widespread contagion or meaningful fallout in the U.S. Both Moody’s Analytics and Capital Economics are downplaying the domestic and global risks. Domestic developers and property owners are not overly leveraged, and U.S. bank exposure is unlike that during the GFC.

Ultimately, the question is how this will affect U.S. property markets. While it’s something to monitor, it’s unlikely to cause significant challenges for U.S. real estate. Chinese investment has been scaled back in recent years, and it appears that U.S. banks are not heavily exposed to Evergrande’s debt. While a default is likely, the risks associated with Evergrande seem to be centered in China.

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