Evergrande is a Systemic Risk for Markets

For nearly a decade, real estate property firm Evergrande, in China, operated at near bankruptcy levels. As long as the government allowed the firm to hold high debt levels, the firm would face no operating risks.

That changed when China decided to scrutinize Evergrande’s debt levels. The tighter lending rules hurt the firm’s cash flow. Eventually, payments to suppliers and builders ended. This caused real estate development to stop.

China has over 1.4 million suppliers and customers losing money from their buildings. Unbuilt units have no value. China said it would step in to force Evergrande to resume property development. It has restricted cash flow, interest on debt due (two last week, one this week), and mounting debt of $300 billion. The government will need to assess the firm’s liquidity problems, the debt exposure of all partners, and assist the firm in paying suppliers. Without doing so, everyone will suffer further.

Foreign investors holding Evergrande’s debt will very likely get wiped out. The stock will not have any value, either. The best-case scenario is that staff who invested in Evergrande’s products will get some funds back. Suppliers will get paid and will resume work. Customers will get a completed property unit.

Debt holders will lose much of their investments. Alternatively, they could agree on a principle payment cut returned later than the maturity date and no interest.