Problems at Evergrande, China’s teetering property giant, are stirring unwelcome memories of the market chaos that followed the implosion of Lehman Brothers roughly 13 years ago. But Wall Street analysts and economists, defying any fears of uttering what could become famous last words, argued that the comparisons don’t hold up.
In fact, analysts at Barclays argued that speculation the Evergrande saga could become China’s “Lehman moment” was far off base.
“Not even close, in our opinion,” they said, in a Monday note.
“Yes, Evergrande is a large property firm. And yes, there could (probably will) be spillover effects on China’s property sector, with economic implications. And yes, it comes at a time when China’s growth has already started to disappoint,” they acknowledged.
“But a true ‘Lehman moment’ is a crisis of a very different magnitude. One would need to see a lenders’ strike across large parts of the financial system, a sharp increase in credit distress away from the real-estate sector, and banks being unwilling to face each other in the interbank funding market,” the analysts continued. On top of that, Chinese authorities would need to make a series of policy mistakes in response to the crisis.
So far, those types of spillovers, or contagion, in economist lingo, remain absent, analysts said.
Bond-market spillovers, so far, have been largely limited to a few high-yield developers, noted Wei Yao and Michelle Lam, analysts at Société Générale, in a note. Major lenders to Evergrande have come under pressure in the stock market, but their borrowing costs have seen little change, the economists noted, while also observing relative calm in China’s money markets, though some early signs of cash hoarding had begun to emerge.
As for the bond market, it seems investors “are differentiating between safe and risky borrowers and expecting limited spillover to the wider financial market for now,” wrote the SocGen economists. They noted that the IBoxx China real estate high-yield index, which tracks the sector’s offshore bond performance, had dropped by nearly 20% year-to-date through last week, with the selloff concentrated across the few risky borrowers, including Guangzhou R&F and Fantasia.
Meanwhile, the sector’s investment-grade index had remained largely stable, they noted. It was a similar story onshore, they said, with credit spreads of lower-rated real estate bonds widening, as investors demanded more of a premium to offset risks, while spreads for higher-rated bonds remained steady. The effect on the broader corporate bond market was even more muted.
That said, jitters around the Evergrande situation were blamed for weakness across global equities and other assets viewed as risky, sending investors into traditional havens, including Treasurys.
While other factors were also seen at play, the Dow Jones Industrial Average
closed with a loss of more than 600 points, or 1.8%, on Monday afternoon, after tumbling 972 points at its session low. The large-cap benchmark S&P 500
ended the day down 1.7% and the tech-heavy Nasdaq Composite
slumped more than 2%.
The yield on the 10-year Treasury note
fell nearly 7 basis points to 1.306% as investors sought out safety in government paper. Yields fall as debt prices rise.
The collapse of Lehman Brothers on Sept. 15, 2008, triggered a market meltdown and a seizing up of credit markets that threatened the global financial system, sparking an emergency response from global policy makers.
Investors, meanwhile, have long fretted about China’s highly leveraged real-estate market, though expectations that Chinese authorities would provide a backstop have ameliorated those fears in the past. Worries about Evergrande intensified amid China’s wide-scale regulatory crackdown.
And China’s ecoomy is “overly dependent” on the real-estate sector, the SocGen economists said. A recent National Bureau of Economic Research working paper estimated that real estate’s contribution to the economy stood near 30%, much higher than every other major economy, including the U.S. at 15%, the U.K., at around 20%, and even higher than Spain before the financial crisis, they noted.
The paper estimated that a 20% decline in real estate activity would result in a cumulative loss of 5-10% of economic output, assuming no financial crisis, they said.
The Barclays team argued that while Evergrande’s liabilities at $300 billion are large, only a small chunk is financial securities. Bank loans, meanwhile, amount to around $35 billion. “Even in a chaotic default with these loans ending up with little recovery, once again, the numbers are simply not large enough to tip the scale,” they said, noting China’s banking system has as much as $40 trillion to $45 trillion in assets, and total loans of more than $30 trillion.
It’s also hard to see an existential threat from Evergrande’s $15.7 billion in offshore liabilities or 56 billion renminbi in onshore bond liabilities, they said.
The fear, they acknowledged, isn’t about Evergrande alone. But they were also skeptical of spillovers that could result in fire sales of Chinese property or send borrowing costs soaring for other property developers, noting some firms have seen bonds trade at more than 15%.
“Evergrande’s balance sheet doesn’t seem a good indicator of the entire real-estate sector; its liabilities have grown far more rapidly than those of the entire Chinese property sector,” they wrote, noting that Evergrande’s profit margins had collapsed over many years, which was also at odds with the overall property complex.
More broadly, the analysts argued that comparisons to the Lehman collapse don’t hold up because crises on that scale are events driven by liabilities.
As wholesale funding markets shut out Lehman in 2008, the investment bank suddenly couldn’t roll over commercial paper, in turn leading to an explosion in counterparty risk as banks became fearful of each other. With U.S. policy makers on the sidelines, Lehman defaulted on its liabilities, sparking a full-fledged financial crisis, the analysts recalled.
China’s situation is very different, they said.
Not only are the property sector’s links to the financial system not on the same scale, but debt capital markets aren’t the primary means of funding. Instead, China remains a command-and-control economy, they said.
That means, in an extreme scenario, that even if capital markets were to shut to all Chinese property firms, regulators could direct banks to make loans to them, keeping them afloat and buying time for an extended “workout,” if needed, Barclays argued.
A widespread “lenders’ strike” would happen only if authorities made a “policy mistake,” allowing the situation to unwind without intervention regardless of systemic dangers to the financial system.
“And we think that’s very unlikely,” the analysts wrote. “The lesson from Lehman was that moral hazard needs to take a back seat to systemic risk.”