Chinese and Global Credit Risk Amid Evergrande Meltdown
The implications and considerations of a Evergrande's imminent default.
Charlie Martin'
Paradise Divide Capital
Founder and Portfolio Manager
Chinese and Global Credit Risk Amid Evergrande Meltdown
Introduction and Analysis: This will likely be on the shorter side, as I am procrastinating my schoolwork to write a little bit about the Evergrande implosion and the implications of its meltdown.
I think it is first pertinent to start with some background information about what Evergrande is. Evergrande is a massive Chinese property developer, in fact it is the 2nd largest property developer in China. Evergrande holds around 305 billion US dollars in debt held by investors and bond holders. They accumulated this debt over the past 10 years and are currently looking like they won’t be able to pay off their debt.
Evergrande’s fate seems almost certain to me at this point. They have $83.5 million dollar debt payment due Thursday, September 22 on March 2022 notes and a $47.5 million dollar payment due on Thursday, September 29 on March 2024 notes. Evergrande has not offered investors any certainty or comfort that they will be able to pay off their debt. They have not even demonstrated the liquidity to pay off their debts due in the next week and a half.
With the Chinese government not fond of business, and looking more like a Mao Tsedong socialist government than a developed country ready for a prospering economy, it is seeming increasingly likely that they will not stabilize Evergrande’s debt. As S&P is reporting, it “does not expect any direct support from Beijing to embattled Chinese Evergrande Group.” Without being too harsh, I will say that I think this is so astronomically dumb of the Chinese government.
A default the size of Evergrande is almost certain to send shockwaves through the Chinese economy. When Lehman Brothers declared bankruptcy in 2008, their debt pile was similar to Evergrande’s debt. A large injection of liquidity was needed to halt the defaults and insolvencies in the banking industry. Around 40% of all Chinese bank assets are held in real estate assets similar to the assets that Evergrande holds. A default of Evergrande, which I think is likely, could cause not only a wave of defaults in the Chinese real estate market, but could cause a liquidity issue in Chinese banks. Thus, leading to economic disaster.
My belief is that the decisions of the Chinese government over the past 3 months, starting with stringent regulations on IPOs, then on China Tech and China Education, and now with lack of liquidity in Evergrande, will put them in a recession. It is hard to put into words how stupid I think the Chinese government is.
I wanted to quickly address Chinese Credit Default Swaps, which have spiked over the past week. It is my opinion that their price is still dislocated. I think that they should be double or triple the level that they were in October of 2020, where now they are at October 2020 levels. Large US institutions such as BlackRock, PIMCO, and others hold Evergrande’s debt and will be looking for credit protection and won’t care what price they have to pay for it. I will leave a chart of Chinese CDS below.
Through all of this, the Chinese Yuan has slipped considerably, which has allowed the US Dollar to become stronger. It will be key to the health of the Chinese economy in the coming days and weeks to stabilize the Yuan.
As far as my global view of this, I think that this contagion stops with China. There are obviously people and institutions outside of China that will suffer losses due to the Chinese debt crisis, but no other developed country is even close to as levered in their investments or as mindless as the Chinese government. I think that the global reaction today, or Monday, September 20, was probably overblown. Equity markets are not in a huge danger if this is only centered around Chinese real estate companies or Chinese banks. But, I could totally be wrong. We will have to wait and see, I guess.
Conclusion:
Thanks for reading. If you have any questions, feel free to ask me. I still have schoolwork to do, but I just love writing these. And any US firm with bullish leverage going into this weekend should be ashamed.