Not since the Lehman Brothers have all financial markets around the world watched just one company: the Chinese property developer Evergrande. This company has pulled down every equity index in the world this week by over two percentage points, decimated commodity prices and roiled the cryptocurrency markets as well.
This company with over two trillion yuan in assets -- that's two percent of China's GDP -- and over $300 billion in debt has been struggling to pay off its debt for several months now. But things may be coming to a head right now. The world is watching if the Chinese government will step in to prevent one company's problems from becoming a systemic issue, scarring many banks, investors and the entire Chinese economy. Or will it persist or desist because of the moral hazard issue?
To discuss this, CNBC-TV18 caught up with Alvin T Tan, Head-Asia FX Strategy at RBC Capital Markets, and Paul Schulte, Founder and Editor of Schulte Research.
If the Chinese government doesn't step in, will we see some kind of a big event this week itself considering that some $84 million of debt is much worrying? Tan said it is important to differentiate between Evergrande's liabilities and debt.
“Most of Evergrande’s liabilities are, in fact, its obligations to its customers who have paid for homes that are being built, its suppliers and the contractors that that are building those apartments. So in many ways, Evergrande is more of a bankruptcy situation than some people have referred to it as some sort of Lehman moment, which I don't think is actually that correct. It is more like General Motors’ bankruptcy than it is like Lehman Brothers in 2008,” he said
He also said that since most of the liabilities are actually obligations to customers, contractors and suppliers, eventually the Chinese government will step in to limit the losses to those parties. However, the debt holders, the bondholders and the banks are likely to suffer losses.
Evergrande bonds are already trading at something like 25 cents on the dollar. So a default to a great extent is already priced in, said Tan.
Also Read: Supply woes in China to keep steel prices elevated; India could see hike post monsoon: JPMorgan
There was a huge reaction across all equity markets. Asked whether that was warranted or were equity markets merely correcting because of their own excesses, Paul of Schulte Research said the numbers are all over the place. "I have heard numbers that about $110 billion is long-term bonds and the other part of it is essentially liabilities that are involved with ongoing construction," he said.
"There are two issues here. One of them is that a lot of this is foreign currency debt, we have to distinguish between foreign currency and local currency. China has had no problem in trashing foreign currency equity, recently in New York with as much as $800 billion worth of equity wiped out in US dollar terms with very little effect on RMB. There is a nasty cold war going on right now," said Schulte.
“I think China may look at the US currency debt, which is trading at like 25-30 cents on the dollar and so the yields are in the 70s. The equity in Hong Kong is already down 94 percent, so foreigners have been utterly and totally trashed on this. So the real question is: What's going to happen to those RMB liabilities?” he said.
If you start to question those RMB liabilities, you could have a terrible cascade in real estate prices, said Schulte. "If people get scared of two things -- of buying a new place and of having the place under construction suddenly, not being completed, and then you then you can get a run. That is what the world is afraid of," he explained.
However, Schulte is confident that the RMB liabilities will be done in an orderly manner and that is fairly baked in the cake.
“I think that Evergrande is going to be like Fannie Mae in 2008. A huge problem that you can just put into receivership into a government. Just stick a government IV in its arm and you are going to have to fiddle with it for a long time to come to keep it from falling apart,” he said
Talking about the China impact, Tan said, yes, it is a China slowdown issue and as Schulte mentioned, the main issue with Evergrande is indeed a symptom. "It is a symptom of the combination of the Beijing's deleveraging policy, which has been instituted just about a year ago, in order to reduce the level of debt in the economy," he said.
Tan also said property prices are a problem all over the world, and China. "So the government has been trying to contain property prices and so it is a combination of that trying to reduce debt and trying to contain property prices, is inducing quite a severe distress that we have seen in Evergrande and to other highly indebted real estate developers," he said.
So, this definitely exacerbates the Chinese growth slowdown, which was already underway, he said. Tan believes that to be the main issue with Evergrande.
For the entire discussion, watch the video
This company with over two trillion yuan in assets -- that's two percent of China's GDP -- and over $300 billion in debt has been struggling to pay off its debt for several months now. But things may be coming to a head right now. The world is watching if the Chinese government will step in to prevent one company's problems from becoming a systemic issue, scarring many banks, investors and the entire Chinese economy. Or will it persist or desist because of the moral hazard issue?
To discuss this, CNBC-TV18 caught up with Alvin T Tan, Head-Asia FX Strategy at RBC Capital Markets, and Paul Schulte, Founder and Editor of Schulte Research.
If the Chinese government doesn't step in, will we see some kind of a big event this week itself considering that some $84 million of debt is much worrying? Tan said it is important to differentiate between Evergrande's liabilities and debt.
“Most of Evergrande’s liabilities are, in fact, its obligations to its customers who have paid for homes that are being built, its suppliers and the contractors that that are building those apartments. So in many ways, Evergrande is more of a bankruptcy situation than some people have referred to it as some sort of Lehman moment, which I don't think is actually that correct. It is more like General Motors’ bankruptcy than it is like Lehman Brothers in 2008,” he said
He also said that since most of the liabilities are actually obligations to customers, contractors and suppliers, eventually the Chinese government will step in to limit the losses to those parties. However, the debt holders, the bondholders and the banks are likely to suffer losses.
Evergrande bonds are already trading at something like 25 cents on the dollar. So a default to a great extent is already priced in, said Tan.
Also Read: Supply woes in China to keep steel prices elevated; India could see hike post monsoon: JPMorgan
There was a huge reaction across all equity markets. Asked whether that was warranted or were equity markets merely correcting because of their own excesses, Paul of Schulte Research said the numbers are all over the place. "I have heard numbers that about $110 billion is long-term bonds and the other part of it is essentially liabilities that are involved with ongoing construction," he said.
"There are two issues here. One of them is that a lot of this is foreign currency debt, we have to distinguish between foreign currency and local currency. China has had no problem in trashing foreign currency equity, recently in New York with as much as $800 billion worth of equity wiped out in US dollar terms with very little effect on RMB. There is a nasty cold war going on right now," said Schulte.
“I think China may look at the US currency debt, which is trading at like 25-30 cents on the dollar and so the yields are in the 70s. The equity in Hong Kong is already down 94 percent, so foreigners have been utterly and totally trashed on this. So the real question is: What's going to happen to those RMB liabilities?” he said.
If you start to question those RMB liabilities, you could have a terrible cascade in real estate prices, said Schulte. "If people get scared of two things -- of buying a new place and of having the place under construction suddenly, not being completed, and then you then you can get a run. That is what the world is afraid of," he explained.
However, Schulte is confident that the RMB liabilities will be done in an orderly manner and that is fairly baked in the cake.
“I think that Evergrande is going to be like Fannie Mae in 2008. A huge problem that you can just put into receivership into a government. Just stick a government IV in its arm and you are going to have to fiddle with it for a long time to come to keep it from falling apart,” he said
Talking about the China impact, Tan said, yes, it is a China slowdown issue and as Schulte mentioned, the main issue with Evergrande is indeed a symptom. "It is a symptom of the combination of the Beijing's deleveraging policy, which has been instituted just about a year ago, in order to reduce the level of debt in the economy," he said.
Tan also said property prices are a problem all over the world, and China. "So the government has been trying to contain property prices and so it is a combination of that trying to reduce debt and trying to contain property prices, is inducing quite a severe distress that we have seen in Evergrande and to other highly indebted real estate developers," he said.
So, this definitely exacerbates the Chinese growth slowdown, which was already underway, he said. Tan believes that to be the main issue with Evergrande.
For the entire discussion, watch the video
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