Will China Evergrande Group Cause A Financial Tsunami?

On 23 September of 2021, China central bank injected liquidity into its banking system. Investors may have taken it as a sign that the Chinese government was bailing out China Evergrande Group. The local stock market rallied on that day, but no coupon payment was made by midnight.  The next day, both the local stock market and price of Evergrande declined.

Has Evergrande defaulted on its coupon payment for its offshore US$2 billion tranche of bond? Technically, Evergrande has 30 days to pay, and we may have to wait till Oct 22 to know the outcome. Another US$47.5 million of coupon payment to offshore investors are due next week. If Evergrande failed to make coupon payment by 22 October, will it cause a financial collapse like Lehman Brothers?

Looking at the biggest buyers of Evergrande’s offshore bond, it is not likely to cause any of the buyers to go into financial difficulty. We had a sell call on Blackrock last week in anticipation of Evergrande’s default, but price of Blackrock had climbed above our recommended sell call’s price by the close of trading on 24 September.

Source: Data compiled by Bloomberg

Note: Includes bonds issued by Evergrande and all of its subsidiaries. Ashmore data as of June 30, BlackRock data as of June, July and September across different funds. UBS data as of April, May, June and July across different funds. HSBC data as of April, June and July across different funds. Holdings may have changed since this data was published. Disclosure rules vary globally.

By latest estimates, Evergrande has debt of US$300 billion. This may sound like a big amount, but this is only equivalent to 1% of Chinese banks’ total loan portfolio. Evergrande’s 20 biggest lenders are commercial banks in China.  To these commercial banks, Evergrande’s loan to book ratio is less than 3%. It should not cause a financial collapse in the Chinese banking system.

The biggest victims of Evergrande’s default are likely to be its contractors and its property buyers. Evergrande’s contractors, suppliers and down lines are not likely to be paid for their work done. Its property buyers are likely to face a delay in collecting the keys to their newly purchased property, but this is where the Chinese government is likely to step in. There is news that the Chinese government will restructure China Evergrande into three separate state-own entities. The objective is to protect buyers who have bought apartments from Evergrande.

The road ahead for Evergrande’s bond holders are likely to be long, but there is not likely to be a big impact like Lehman Brother that was talked about. The Chinese government will act to protect its citizen and Evergrande’s troubles are not going to set off a systemic crisis—the so-called “contagion” in the financial sector.

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