- Form of default seems inevitable for indebted Chinese real estate developer Evergrande
- We take a look at why markets don’t think a default will put sand in the world’s financial cogs
- However, concerns are spreading to other developers, which could increase volatility.
In August, the Chinese authorities drew up the “three red lines” policy imposing constraints on the balance sheets of real estate developers with the long-term aim of increasing financial stability. Evergrande is one of the biggest developers and one of the most successful. To respond to these political constraints, she started updating the apartments and selling her assets. Short of cash, he even settled his debts by swapping properties with creditors. These liquidity problems have been helped by the slowdown in the real estate market, reducing the margins on the apartments it sells. Things have gotten so bad that bondholders are going to sweat on coupons to be received on the 23rd of this month.
In its most recent financial statements, Evergrande had NZ $ 125 billion in outstanding borrowings and much more owed to commercial creditors. For context, these loans represent about half of the bonds of Australia’s largest bank, the CBA, or about 100 basis points of the capital of the Chinese banking system (which currently stands at 11.9%), or one seventh of Lehman Brothers’ debt when it failed.
So, should we be worried?
Evergrande has NZ $ 125 billion bonds outstanding, but it is not a service company. Because it has durable assets, there may be some salvage value. The scale of the losses is absorbable throughout the financial system, but as we have learned from previous crises, trust between financial institutions is vital. For now, the Chinese interbank lending market is unfazed. Below we have created a composite of the debt spreads of five of Evergrande’s lenders showing that confidence prevails.
In formulating the “three red lines policy”, the Chinese authorities have taken into account the implications of the failure of real estate developers and have experience in the surgical removal of dominoes. Last year saw the bailout of Anbang Insurance, and the authorities also immunized the entire industry against the bankruptcy of Baoshang Bank.
More than 10% of Evergrande’s debt is issued abroad. Against the backdrop of Chinese regulators’ desire to see companies more autonomous (and fears over data sovereignty), it is plausible that recovery rates are lower abroad. Debt registers list most of the world’s major asset managers as holders, which likely impacts 401 (k) balances, but we note that its 2025 debt was marked below 50 cents in dollar in the past three months.
There may be some form of Chinese government intervention to ease the pain. It is very common in China for families to put deposits on houses before they are built, rather than developers building properties in the hope that buyers will show up. This means that there is a lot of depositors’ money at stake, around 53 million square meters of homes worth, motivating the Chinese government to ensure that these people do not end up homeless.
Looking beyond Evergrande to the broader development sector is less reassuring. For the most part, other developers are not in a similar position, given that they are not so extensive and still have access to funding, but there are a worrying number of exceptions. We demonstrate this below by plotting a composition of the debt spreads of 5 of the largest players. This is important, not only for the direct financial implications and the potential to constrain broader liquidity, but also given the feedback loop through construction activity, a great source of jobs.
The market has good reason to believe that Evergrande’s default on its loans is manageable, but that shouldn’t amount to complacency. We’ve combed through Evergrande’s disclosure to the biggest debt holders. We will continue to monitor all of the undisclosed and less obvious ramifications, including the wealth management products that it supports but keeps off-balance sheet. Examples like this reinforce the fact that Australasian assets may be easier to understand secondary derivative exposure to Asian growth.
Simon Pannett is a senior credit analyst in the fixed interest team at Harbor Asset Management.