Here’s why the Evergrande crisis is not China’s ‘Lehman moment’
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The Evergrande headquarters is seen in Shenzhen, southeastern China on September 14, 2021, as the Chinese property giant said it is facing “unprecedented difficulties” but denied rumours that it is about to go under.
AFP / Getty Images Evergrande is a holding company. But, the Evergrande crisis does not have the same potential effect on the international financial markets as the Lehman meltdown. Evergrande held land and Lehman financial assets.| AFP | Getty Images
Evergrande holds physical assets
However, when it comes to the scale of potential impact on international financial markets, analysts point to a major difference between the Evergrande crisis and the Lehman collapse: Evergrande holds land, while Lehman held financial assets.
Evergrande has cash flow problems, but talk of systemic risks is “a bit overdone, frankly,” Rob Carnell, regional head of research for Asia-Pacific at ING, said Wednesday on CNBC’s “Squawk Box Asia.”
“Let’s face it, this is not Lehman’s, this is not LTCM,” Carnell said, referring to a large American hedge fund, Long-Term Capital Management, that failed in the 1990s. “It is not a hedge funds with large leveraged positions, nor a bank where financial asset prices are hurtling toward zero. The company is a property developer with a large amount of debt. In dollar terms, it’s around 300 billion.
Evergrande hopes that, if Evergrande is able to get cashflow into its assets, it will be able to finish its projects and sell them.
On Wednesday, Evergrande’s real estate division announced that it would pay the interest in time for a bond on the mainland denominated as yuan.
Larry Hu, Macquarie’s chief China economist, stated Tuesday that Evergrande faces a liquidity crisis despite owning a large bank of land. It was noted that the assets of the developer are mostly land and housing projects valued at just over 1.4 billion yuan ($220billion).
This is not a Lehman Moment-style contagion story, and there will be no such thing.
The collapse of Lehman Brothers in 2008 led to a crash in financial derivatives — credit default swaps and collateralized debt obligations — “causing the market to doubt the health of other banks,” Hu said.
Hu said, “But it is very unlikely that the Evergrande scandal would cause land prices to crash.” It is clear that land has a higher value than financial instruments. China is a great example of this, as the Chinese government has monopolized land supply.
“As the result, [the] local government has a strong incentive to stabilize land price. “In the worst case, local government might even purchase back land,” he said.
Strong government control
Another critical difference in Evergrande’s case is the greater level of government control and involvement in China’s real estate industry.
Analysts at China Beige Book reported Monday that Chinese banks and other entities were government arms first and intermediators second. Even non-state financials could be controlled in ways that are rare to see outside China. The state has the option to declare bankruptcy commercially.
The report stated that Beijing says to lend and lend. It doesn’t matter if you receive your money back or not. It is clear that there are no Lehman Moments like this.
This month, the legendary U.S. bank for investment collapsed in an important moment of global financial crisis. In the midst of the U.S. housing boom, the bank backed tens to billions in securities that were backed with risky mortgages. Lehman Brothers was ultimately let to die by the U.S. while other financial institutions were rescued.
In China’s case, Beijing has tried to allow the market to play a greater role in the economy by letting more state-owned enterprises’ loans default.
Authorities will be patient in Evergrande’s case as they have two goals of preventing excessive risk-taking and maintaining stability in the property market, said Macquarie’s Hu.
“Policymakers would choose to wait first, then step in later to ensure an orderly debt restructuring,” he said. It is highly unlikely that a wholesale bailout will be possible and investors/lenders may suffer significant losses. However, the government will make sure the apartments that have been pre-sold are completed and shipped to the homebuyers.
Hu also pointed to the Chinese government’s recent track record in restructuring giants such as Anbang Insurance, Baoshang Bank, HNA Group and China Huarong Asset Management. “China’s banking system has an annual profit of 1.9 [trillion yuan] and a provision of 5.4 [trillion yuan], which could easily absorb the loss from Evergrande,” he said.
‘China has the tools,’ IMF says
In Evergrande’s case, the property developer has more direct ties to foreign investors than the bulk of China’s economy.
According to UBS investment bank, $19 billion of total offshore bonds are outstanding by the company. That’s roughly 9% U.S. Dollar-denominated Chinese bond bonds. The report stated that Evergrande’s $313 billion in total liabilities is 6.5% of China’s entire property sector liability.
UBS analysts believe Evergrande will restructure its debt and that bonds prices will rebound from lows to limit spread.
They also discussed possible spillovers if Evergrande enters the less probable scenario of complete liquidation. This could be due to the loss of exposure banks, or the selling of emerging market credit.
International Monetary Fund Chief Economist Gita Gopinath told Reuters this week the organization believes “China has the tools and the policy space to prevent this turning into a systemic crisis.”
The IMF can organize bailouts for countries or regions in financial stress.
Even though public government statements in recent months have called for preventing major financial risks, Chinese authorities’ intervention is not a given.
Chinese officials have not yet made major public statements on Evergrande.
At a press conference last week, a National Bureau of Statistics spokesman said the department is monitoring the difficulties of some large real estate companies and the potential impact on the economy.
Moody’s estimate that China’s real estate and construction markets account for nearly 25% of the country’s national GDP.
Many Chinese families took out mortgages because they were afraid that house prices would rise. The government tried to calm the market over the past few years by limiting the amount of debt that developers are allowed to take.
— CNBC’s Eustance Huang and Weizhen Tan contributed to this report.
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