MW Wall Street yawns as China property giant nears default: What investors need to know
By William Watts
'Investors are confident the country's authorities will limit any financial contagion': economist
Evergrande, a Chinese property giant nursing more than $300 billion in debt, is seen as likely to default next week. Global investors don't seem too worried, but the looming crunch still has potential to shake up financial markets, analysts warned.
"While Evergrande's bonds and shares have sold off, spillovers to other assets, both in and outside of China, have so far been limited, suggesting that investors are confident the country's authorities will limit any financial contagion," said Thomas Mathews, markets economist at Capital Economics, in a note.
Fears of a bursting property bubble have long been a concern for investors when it comes to China. A heavily leveraged real-estate sector makes up more than 28% of China's economy, according to the Financial Times.
And Evergrande's dire situation is sparking debate over how Chinese authorities should respond. Meanwhile, holders of Evergrande's approximately $19 billion in dollar-denominated bonds are left to wonder what will become of their investments. And shares of Evergrande have plunged 83% in Hong Kong.
Global markets have been largely unswayed. Major U.S. stock indexes were on track for weekly losses, with the Dow Jones Industrial Average down 0.1% and the S&P 500 on track for a 0.5% decline. Those modest losses, however, have been largely attributed to worries equities were overdue for a pullback amid uncertainty over the toll of the spread of the delta variant of the coronavirus.
Should investors be paying more attention to the Evergrande situation?
FitchRatings, a credit ratings firm, on Sept. 7 downgraded Evergrande's rating to CC from CCC+, indicating they saw some sort of default as probable. Evergrande is one of China's top three property developers, although the residential housing market is highly fragmented, Fitch analysts noted in a Sept. 14 report.
Evergrande's market share in 2020 was only around 4%. Fitch said the risk of significant pressure on house prices in the event of a default would be low, unless the restructuring or liquidation of its assets becomes disorderly. "Fitch believes this is something the authorities will want to avoid," the analysts wrote.
But faith in that scenario may have been shaken after Reuters reported that the editor of the state-backed Global Times newspaper had warned that Evergrande shouldn't assume it's "too big to fail."
Analysts at UBS, led by Kamil Amin, said in a Thursday note that the potential for market spillovers will depend on whether Evergrande restructures or fully liquidates. The analysts wrote what they remained confident that a restructuring remained the most probable outcome.
"In the event of a restructuring, we expect the bonds to bounce off their lows and contagion to be broadly limited," they said.
But in the event of liquidation, there would likely be a "high degree of contagion," they warned. The spillovers would occur, they said, through three channels:
Why do investors seem to be ignoring the potential for spillover effects? The lack of concern reflects expectations that, ultimately, "the Chinese government will end up paying for it," said Tom Essaye, founder and president of Sevens Reports Research, in a Friday note.
"One of the best ways to think about China is that it's a country, but it operateslike one large company," he said. While there are "private" banks and corporations, in the end the Communist Party effectively "owns anything and everything" if it wants to, he wrote.
"And because of that, there really isn't global contagion risk with Evergrande because in the end, and as far as we know, the loans to Evergrande were made by Chinese banks that are implicitly backstopped by the Chinese government, and the Chinese government's balance sheet can easily handle the Evergrande losses which are valued around $303 billion of liabilities," he said.
Also, investors may be taking the Evergrande situation in stride because China's financial strains "have been seen for some time as a slow-motion train wreck, not something that has suddenly appeared," said Steve Barrow, head of G-10 strategy at Standard Bank, in a Friday note.
Financial collapses including Long Term Capital Management, Barings and Lehman Brothers, "came out of left field," he said, and produced domestic and international shock waves, he noted. But "China's different financial support structure and the elongated nature of the difficulties might have desensitized global markets to the strains that seem to be coming to a head right now in the case of Evergrande."
That said, investors have previously been caught "on the hop" by Chinese authorities, noted Capital Economics' Mathews.
It wasn't until three weeks after the People's Bank of China took over Baoshang Bank in 2019 that credit conditions deteriorated as investors reassessed the implicit government backstop of the sector, he said, noting that authorities eventually did step in to stabilize conditions, preventing much of a reaction in markets outside China.
But 2015 saw broader ripples sent through markets, he noted, with global equities falling sharply in August after a 40% fall in Chinese stocks saw authorities unexpectedly let the renminbi currency fall.
Mathews argued that one of the lessons of those previous episodes is that "China's authorities would ultimately step in to stabilize domestic financial markets in the event of a large-scale default by Evergrande," but may first allow a temporary deterioration in financial conditions.
-William Watts
$(END)$ Dow Jones Newswires
September 17, 2021 15:50 ET (19:50 GMT)
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