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Evergrande Fall Risk Only a ‘Short-Term Inconvenience’ for China: Trivium

Bank loans to developers are usually heavily collateralised, indicating they should be able to recover their full value after the collateral is sold, says research firm Trivium China

Evergrande is likely to default on a $83.5 million interest payment due on one of its bonds this week, analysts say. Photo: Reuters.

 

A default by China’s teetering property giant Evergrande would likely be more a short-term inconvenience for its financial system than a systemic risk, says research firm Trivium China.

It doesn’t expect a default by Evergrande will have a big impact on the banking system because loans to developers are usually heavily collateralised, indicating they should be able to recover their full value after the collateral is sold, said Trivium analyst Dinny McMahon, author of the book ”China’s Great Wall of Debt.

The government also would step in as a last resort to limit any economic fallout or social unrest, he said.

China Evergrande, once China’s second-largest real estate developer, is listing under a sea of debt. China’s housing authority warned major banks on Wednesday that Evergrande Group will not be able to pay loan interest due on September 20, according to a Bloomberg News report, underlining the threat of a broadening impact from the developer’s liquidity crisis.

Beijing’s measures to reduce sky-high home prices will push more private and small real estate developers out of business as they face constraints on borrowing, thinner profit margins, and compressed consumer demand, said Alicia Garcia Herrero, Chief Economist Asia Pacific at Natixis Asia Research, in a note on Wednesday.

Fitch Ratings said on Wednesday that numerous sectors could be exposed to heightened credit risk if Evergrande were to default. That would reinforce credit polarisation among developers and could result in headwinds for some smaller banks, but it also said that the overall impact on the banking sector would be manageable.

Asia Financial asked McMahon for his thoughts on how a possible Evergrande collapse would play out. Excerpts:

 

AF: Will Evergrande be bailed out? 

McMahon: We don’t expect that either the provincial government or the central government will bail out Evergrande. That said, we expect local governments – led by Guangdong and Shenzhen – will do all they can to limit the economic fallout of a default.

That means that after Evergrande enters restructuring, a local government entity will probably emerge to take control – and probably inject some capital – into the restructured entity. However, it will only do so after Evergrande has sold off a lot of its assets, and restructured the terms of its remaining debt.

Local governments around the country also have an interest in ensuring that Evergrande projects don’t halt construction and, if they do, that the halt is only temporary. We expect that if Evergrande defaults its asset sales will accelerate in order to provide the funds necessary to keep Evergrande’s projects alive.

The authorities will have a preference for other developers stepping in to acquire Evergrande developments on a market basis, but if buyers don’t emerge local authorities will consider mobilising state resources and playing the role of buyer of last resort.

 

AF: How would an Evergrande default impact China’s banking system and the real economy?

McMahon: We don’t expect that a default by Evergrande will have a big impact on the banking system. Banks’ loans to developers are usually heavily collateralised which means that the banks are likely to recoup the full value of their loans once the collateral is sold off.

Hence, over the long term, the banks might be able to avoid meaningful losses on an Evergrande default. The challenge will be that it usually takes at least 18 months after a creditor launches a claim in the court before the collateral is liquidated.

Over that period banks will need to take impairments, putting pressure on their capital. Still, that’s likely to be a short-term inconvenience rather than a long-term challenge to financial system stability.

 

AF: Do you think Evergrande would be able to sell its non-property assets, such as stakes in Hong Kong-listed units Evergrande New Energy Vehicle Group? 

McMahon: I would expect that as part of the restructuring process Evergrande’s non-property business will be spun off. It’s hard to imagine that a restructured Evergrande will still be involved in EVs. However, I don’t have any ideas as to who potential buyers might be.

 

By Iris Hong

 

ALSO ON AF: China Evergrande’s Liquidity Crisis Deepens On Report of Interest Payment Miss

 

 

Iris Hong

Iris Hong is a senior reporter for the China desk, and has special interests in fintech, e-commerce, AI, and electric vehicles. She began her career in 2006 and worked for Interfax News Agency and for PayPal before joining Asia Financial in July 2020. You can reach out to Iris on Twitter at @Iris23360981

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