Do you think Evergrande is really the Lehman of China? Or is the crisis overhyped?

Evergrande, the biggest real estate developer in China having debt equal to 2% of China’s GDP. It also has $300 billion in liabilities and has seen a fall of 85% in its share price!

Why did this happen?

  • Property sales in China have slowed down significantly.

  • The company was riding on the wave of surging property prices and high demands.

  • Though, the primary reason is attributed to the high levels of debt it accumulated during its rapid expansion.

Analysts have generally indicated an Evergrande default wouldn’t spur a crisis of confidence like the one that followed the Lehman Brothers collapse.

What’s your take on this?

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Actually, the crisis is triggered by the Chinese regulators. Realizing that the entire real estate sector is extremely leveraged (very high debt), the regulators imposed asset to debt limits last year (called the “three red lines”). A bunch of real estate companies were able to pay down debt to get under the limits. Evergrande failed. So they were unable to raise more debt to pay for ongoing constructions and debt interest payments. This leads to the liquidity crisis.

As to the question whether or not this is the Lehman of China, it’s unlikely to be so. The debt is mostly domestic (from WSJ). So the contagion risk outside China is not that great…

Evergrande already missed interest payments to international bond holder last week - so it’s likely that some major restructuring will happen to get rid of the bad debt. The question is, who will get bailed out? My sense is that it will be in the following order of priority:

  • Local homeowners who have made payment but have not received complete homes
  • Local vendors/contractors who have been receiving payments in the form of IOUs and even unfinished apartments…
  • International investors are probably going to be left holding the bag…

Within the domestic market, the contagion risk is beyond the debt though. There’s a real crisis of confidence → no one wants to buy new/unfinished homes → which leads to a decline in housing prices → which can turn into a larger liquidity risk for other real estate developers.

Just today another property developer reported that they missed bond payments to international investors.

I wrote about this issue more expansively here