Evergrande teeters further as default worries ripple across markets

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Fears of a potential fallout from the teetering property giant China Evergrande resulted in declines across a number of sectors on Monday.


Amid escalating anxiety about a default, Evergrande shares fell 11% in Hong Kong Months, down 74% since worries began to raised about the highly leveraged developer in the spring.


It has loan payments on bank loans due today and is scheduled to make bond repayments on Thursday, with around US$313bn of liabilities that appear to be on the brink of default.


Last week the company warned of “tremendous pressure” on its cashflow and liquidity, saying all the media attention was making it difficult to sell off properties and service its debt pile, but that it was exploring “all feasible solutions” to alleviate its liquidity crisis.


Analysts said some sort of default is inevitable, but Chinese authorities have reportedly warned major lenders not to expect repayment.


Hong Kong’s Hang Seng index fell 3.3% on Monday, with the property, construction, banking and finance sectors the worst hit, while an index of Chinese high yield bonds rose to 14%, the highest in nearly a decade.


“The contagion from Evergrande may spread to other developers and now the whole Chinese credit market shows a dangerous deterioration in investor confidence and it seems likely that only government intervention can halt the snowball from rolling,” said Allan von Mehren, chief analyst at Danske Bank.


“No doubt Beijing is watching the situation closely but it is unclear when authorities will step in. To some extent the developer’s woes have been engineered by the government with tighter rules on debt implemented last year and they want to show that uncontrolled debt has a price. But they also do not want to see a deep financial crisis sending Chinese housing and the economy into a deep recession.”


Evergrande’s liabilities amount to roughly 6.5% of China’s total property sector, UBS noted, with the result of a liquidation hitting the banking sector would with low recovery values for its debt, lower investor confidence, and lower cashflows to suppliers in the property sector.


“Currently EG alone is not viewed as enough to place pressure on the financial sector; however, other high-cost developers are now being monitored by the team as there is a heightened risk of liquidity issues. These issues pose a growing risk to property sales, construction starts and completions, which in turn are a key driver of steel, cement, copper and aluminium demand growth,” UBS added.


As well as the impact on commodities, spill-over to global financial markets could come from the US$7.4bn of its US-denominated debt held by overseas investors, with investors including Ashmore Group (LSE:ASHM), Allianz and BlackRock (NYSE:BLK).


As the company has a grace period of 30 days before an official default is called, so “this story is likely to keep on giving”, said market analyst Jeffrey Halley at Oanda.


While some commentators have warned this could be a ‘Lehman Brothers’ moment for China, echoing one of the first big dominoes to fall in the 2008 global financial crisis, by no means everyone is of this opinion.


“You’ve got all kinds of banks and insurers caught in the net but ultimately, I don’t see this as a Lehman’s moment right now,” said Neil Wilson at Markets.com.


“But combined with the tech crackdown it’s probably another reason why investors will be seeking to avoid China in the near-term. What we are seeing today is how risks get priced gradually then suddenly. It is definitely though a major cause for investor concern right now and it is possible we see further losses before the dip finally gets bought. A market so well-conditioned to buying the dip will find it hard to resist.


“But the Fed meeting this week will be of particular importance – does a Chinese property collapse and energy crisis collide with expectations for a Fed rate hike next year and biting inflationary pressures? That would be a pretty nasty cocktail for risk appetite and I think these are the risks being priced into today’s (and possible further) selling.”


Seeing a default as “inevitable”, analyst Joachim Klement at Liberum said he expects Beijing authorities to follow the template of the collapse of the LTCM hedge fund in 1998, with the company allowed to collapse with the most profitable parts of its business bought up by rivals and the debt underwritten by either the People’s Bank of China directly, or by a consortium of Chinese commercial banks with the help of a liquidity injection by the PBOC.


“In this base case the collapse of China Evergrande should merely lead to short-term setbacks in stock markets but not a lasting effect throughout 2022. Thus, these setbacks could be used to accumulate stocks at more attractive valuations,” Klement said, seeing less than 10% chance of a disorderly collapse.


Commodity contagion


Commodities, mining shares and Australian stocks were also being sold heavily this morning.


China’s property sector alone has a sizeable share of global commodity consumption, broker Liberum noted last week, with steel flow of around 380mln tonnes per annum (Mtpa) or 20% of the global total, 20% of global copper, 9% of aluminium, 5% zinc 8% nickel.


“Evergrande’s potentially a big deal to Commodity World,” said analyst Tom Price.


Russ Mould, investment director at AJ Bell, said the situation also has uncomfortable echoes of 2015 when fears about Chinese debt prompted a big and broad-based market correction.


“A combination of inflation and a global slowdown, namely stagflation, is the big fear stalking investors and this will need to be addressed if the markets are to recover their poise.”


The commodity price falls also follow China’s Premier Li statement over the weekend that China will use “market tools” to stabilise commodity prices.


Halley said this was likely to mean China would release more commodities onto domestic markets from its strategic reserves.


“As a price taker, and not a price maker, there is only so much China can do to impact prices in the medium term,” he said.

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