Evergrande may not be China’s Lehman, but are markets being too complacent?

Nine years ago US hedge fund manager Andrew Left, of Citron Research, penned a report on Chinese real estate group Evergrande, claiming the business engaged in aggressive accounting and was actually insolvent.

At the time the developer, which had floated in Hong Kong in 2009, had a net debt of less than $12 billion (€10bn). This weekend Evergrande, the most indebted company in the world, is on the brink of going into default, laden down by a mind-boggling $300 billion (€254.6bn) debt pile, not much more than the expected size of Ireland's national debt for the end of the year.

But while short sellers – investors that place bets that a stock will fall in value – have made a killing as Evergrande’s share prices has plummeted by more than 83 per cent in the past six months, Left has been stuck at the sidelines: shackled by a Hong Kong financial markets trading ban for market misconduct in connection with his 2012 tome.

By the time the ban runs out next month what will be there of Evergrande for Left to trade?

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Market concerns about the sustainability of Evergrande's debt pile have been mounting in recent years amid slowing home sales in China. The country's central bank mentioned it in a financial-stability report in 2018 as behaving like a financial holding company that could pose systemic risks.

Then there were rumours last October – furiously denied at the time – that it had asked the government for help to avert a cash crunch. But the company’s shares and bonds have been in free-fall since the middle of the summer.

Founded under the name Hengda Group in 1996 by Xu Jiayin, an extremely well connected member of the Chinese People's Political Consultative Conference advisory body to the Beijng government, the company rode China's extraordinary property boom in recent decades as hundreds of millions of rural migrants moved into cities, driving economic growth.

Evergrande currently owns more than 1,300 development projects, with its cranes dominating the skylines in more than 280 cities across China.

It has also branched into other areas, including investments in an electric vehicle-maker that has yet to sell a car, a soccer club, a theme park, life insurance and bottled water.

Creditors

Chinese authorities reportedly told the group's bank creditors this week not to expect scheduled interest payments on Monday. Fitch Ratings estimates that it faces bond interest payments of $129 million before the end of the month. Evergrande has warned debt investors twice in recent weeks that it could default on certain debts, potentially triggering a "cross-default" on other borrowings.

In addition, Evergrande owes billions of dollars to suppliers and apartment buyers that have paid up before completion – including handing over a deposit and mortgage borrowings.

The company also sold wealth management investments to help fund its projects to tens of thousands of retail investors, including its own employees.

Groups of angry small investors and home-buyers, looking to get the flats they have paid for and which Evergrande hasn't the cash to complete, gathered at company offices this week, including its headquarters in Shenzhen.

Up until now market jitters stemming from Evergrande’s woes have been contained to Asian equities and bond markets, with other Chinese property companies having succumbed to selling pressure in recent weeks amid speculation about who could be next. Its main banks are local Chinese lenders.

However, the list of holders of Evergreen's bonds – some of which are now trading at about 25c on the dollar, indicating investors expect that they will lose about three-quarters of what is owed – include major international names like Blackrock, Fidelity, Goldman Sachs, PIMCO and Amundi.

Systemic risk

Colm D’Rosario, a Dublin-based co-head of emerging market corporate and high-yield bonds at Amundi, told The Irish Times he thinks the fallout will be contained, and that the Chinese government will take “supportive action to ensure market stability and prevent any systemic risk”.

“We also believe...that contagion to the broader market will be contained even if there can be some volatility in the coming months,” he said.

“Indeed, China faces other macroeconomic challenges in the near term and this is, in our view, an incentive for the government to ensure an orderly resolution to this disruptive event.”

Figures out this week show that retail sales grew only 2.5 per cent in August, little more than a third of the rate economists had expected, and that construction investment contracted 3.2 per cent in the first eight months of the year. It has left observers questioning whether the official government forecasts for 6 per cent economic growth still stack up.

Some have taken comfort from the Chinese central bank injecting the equivalent of $14 billion into the country’s banking system on Friday to prevent a funding squeeze. It’s the first time in over a month the institution had pumped more than $2 billion into the market in a single day.

Arthur Lau, head of Asian fixed income, excluding Japan, at PineBridge Investments said that the Chinese government would be keen to ensure a stable housing market and that it would not allow Evergrande's "imminent default to be too disruptive for the sector".

Rescue

But comments on Friday from the editor-in-chief of state-backed Chinese newspaper Global Times, Hu Xijin, that Evergrande should turn to the market for a rescue, rather than the government, could suggest that Beijing is not going to ride to the rescue. Could this lead to a domino effect?

Xijin may be right in saying that Evergrande’s potential bankruptcy is unlikely to trigger a systemic financial storm like Lehman Brothers’ collapse (13 years ago this week) because it was a real estate company, not a bank.

But a messy massive default in a key sector in the world’s second largest economy could have far-reaching consequences.