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Why Evergrande default is not a Lehman moment

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The unfolding Evergrande crisis in China is sending shivers down the spine of markets across the world. Investors fear a systemwide collapse similar to one that happened in 2008 in the US.

Why Evergrande default is not a Lehman moment
The unfolding Evergrande crisis in China is sending shivers down the spine of markets across the world. Investors fear a systemwide collapse similar to one that happened in 2008 in the US. Is the fear legit or misplaced, Kristal.AI the leading private wealth advisor of India shares its analysis of the situation and why it is not a Lehman event.
The memory of the financial crisis of 2008 is still fresh for many investors. Then it was a big company, with significant exposure to real estate. Now also there is a big company with even a bigger exposure to real estate. Hence a frenzied comparison. As a global investment platform, the advisory team at Kristal.AI has been keenly following the event and thinks that reality is different than what's being perceived.
We believe that there are big differences between the current crisis and the bankruptcy of Lehman Brothers, Hence don't expect the Evergrande risk to be another Lehman / AIG event. The Chinese government will surely intervene but we don't think they will bail them out. Instead it might let Evergrande default but in a more controlled manner. Hence there is likely to be contagion in Chinese short-term paper, bond-linked structured deposits and the High Yield market in general. But we also believe this could present buying opportunities down the road in high-quality issuances.
Who is Evergrande?
Evergrande Group, earlier known as Hengda Group, is the largest real estate developer in China. It was founded in 1996 during a period of mass urbanization in China. The company made its mark on infrastructure fuelled Chinese economic growth in the 2000s and post the Global Financial Crisis.
However, it is also the most indebted company not only in China, but also in the world, with liabilities standing close to $300 billion. The accumulation of debts resulted in large interest payments and cash flow mismatches. With deteriorating asset quality and increasing US dollar debt, there were warning signs for the last couple years. So, not entirely surprising that we are seeing signs of stress as the Chinese economy, as well as credit impulse, slowed.
The company is on the edge of bankruptcy with bonds trading near 25 cents on the dollar. With the stock trading down 90% from all-time highs and below its new issue price over 5years ago, many have compared this to the Lehman / AIG moment of 2008.
Why there won't be a repeat of 2008
Even though Chinese banks hold 80 percent of the debt they will not be affected by its failure as their balance sheets are strong. Banks are plush with deposits right now thus reducing exposure and they have been preparing for this event for the last quarter or so. Moreover China has sufficient forex reserves to simply bail them out if it does start to look like it can hurt the larger economy i.e there is a systemic risk
When we look at Chinese credit, we are seeing spreads widen in pockets like short-term commercial paper, bond-linked structured deposits and overall HY but it is still orderly. Also, high-quality names have been immune till now to a large extent. Having said that, it is fair to assume that if Evergrande does default, there is a high likelihood that Chinese HY will suffer and we could see contagion. However, that might actually present buying opportunities in high quality issuances like Country Garden, Sino Ocean etc. that could benefit and even take over the more lucrative projects from liquidation of Evergrande assets.
Also, the market has already accounted for the bad news. Evergrande bonds are already trading close to 25 cents on the dollar, i.e. they are already pricing a high probability of default. So, unlikely to become systemic from here on even though we might see spreads widen a bit in the high yield space. One place outside of China that could see some pressure is the European luxury segment (e.g. LVMH) where ~50% revenues come from China and to that extent there could be underperformance in that space - again not enough to be systemic but enough to serve as a headwind.
"Bail-out" not our base case
The government doesn't want to come across as trying to save the rich at the expense of the masses and that's why they haven't stepped in till now ("Common Prosperity Initiative"). We think that the Chinese government is unlikely to step in and would rather allow a controlled default based on the current state of affairs. That's also in line with market pricing right now.
The author, Asheesh Chanda, is founder and CEO at Kristal and also the fund manager of multi-asset global fund, The Founder's Fund. The views expressed are personal
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