In the middle of this month, We commemorate 13 years since the US investment bank Lehman Brothers went bankrupt, which caused global markets to enter financial collapse.
Now, a similar problem would be brewing in China with the liquidity problems that are occurring with a giant of the construction and commercialization of real estate loans, Evergrande.
The problem is important. Evergrande is the world’s most indebted company, saddled with a $ 300 billion pile of debt and facing $ 669 million in interest payments this year and has borrowed about $ 88.5 billion from banks and other financial institutions with nearly half maturing in less than one year.
Attending to the different publications of the rating agencies, Evergrande presents high liquidity risks of the company over the next 6 to 12 months, limited financial flexibility and poor recovery prospects for its creditors.
The unrestricted cash available at the end of June 2021, not enough to cover your short-term debt and your long-term debt maturing in the next 12 months.
Furthermore, it is unlikely that the company will be able to raise enough new funds to refinance it, given its impaired access to financing in national and offshore markets. Evergrande will have to rely on asset sales or investments from potential investors to generate resources, but these fundraising activities carry great uncertainties.
Your cash flow problems aren’t new. In 2020, the real estate developer had a major liquidity scare and Evergrande sent a notice to the Guangdong provincial government, warning officials that its payments scheduled to be due in January 2021 could create a liquidity crisis and lead to a major default on everything. the financial sector. In this case, the potential catastrophe was averted early, because a group of investors decided to waive their right to enforce a $ 13 billion redemption.
Hence, there is talk of the non-payment of the debt and its importance is not small. Evergrande is one of the top three developers in China by sales volume, with a standardized operating model. The company, which was founded in 1996 in Guangzhou, has rapidly expanded its business in China in recent years. According to its website, it has 45.8 million square meters of urbanized land and more than 1,300 real estate projects covering more than 280 Chinese cities.
And his eventual tended to a first victim. Hengda is a 60% onshore subsidiary of Evergrande, one of the top three property developers in China by sales volume, with a standardized operating model. It also owns 100% of Tianji, which in turn owns 100% of Scenery Journey.
All of this sounds like the similar case of Lehman Brothers that we reviewed at the beginning, which was the tip of the iceberg for the collapse of the US and global economy. We compare both situations, similarities and differences.
Similarities: systemic entities and a low interest rate scenario that fueled private debt
Both in the case of Evergrande and Lehman Brothers we start from two giants linked to the financing of real estate projects which, in turn, were connected to the bank to acquire their debts, systemic entities.
The Chinese banks have direct exposure to loans and bonds to Evergrande, as well as exposure to off-balance-sheet wealth management products through trust loans. For what its fall would compromise part of the Chinese banking system, in both cases the propagation of the disaster was served.
Low interest rates fueled their housing bubbles. In the United States, after the dot-com crash, low interest rates led to the channeling of investment through the brick. As interest rates rose, they were looking for clients who will pay higher interest because they have a more deteriorated risk profile … subprime mortgages expand.
In the case of China, low interest rates began in 2008. China’s foreign model fell after having a current account balance with a surplus of 10% of GDP and opted for a model of internal demand.
Consequently, between 2010 and 2020, when GDP doubled again, China did so by tripling its total private debt burden to $ 43 trillion, so that it now officially stands at more than 280% of GDP.
In both cases prior to the collapse, private debt rose above GDP growth rates and this happens when investors tend to be unproductive. The American model was forced to rebalance itself, and China has not yet reached that point.
Differences to consider
The differences are found in the market reaction to date. If Evergrande’s problems started last week, the truth is that the global stock market represented by the selective MSCI World Index has fallen just 0.2% over the past week, and remains more than 1% below all-time highs. after last week’s nerves. And this week we have seen a Monday of declines and a Tuesday of slight recoveries.
Investor perception has nothing to do with Lehman Brothers. At that time we were in a real panic in the market. The S&P 500 had fallen nearly 5% as of the end of the day on September 15, 2008, and the Lehman effect on money market funds and the commercial paper market were serious problems.
Investors are more aware of the evolution of the economic outlook and monetary policy than the monetary authorities and on Evergrande they seem confident that the Beijing authorities will use their vast control over the Chinese economy to limit the damage. AND there is no evidence, at least so far, of contagion in US markets.
At the same time, unlike the US market from 2007 to 2008, China doesn’t have too many complex financial products that may affect the operations of the housing market and Beijing’s ability to control and monitor the market is better than that of the United States.