Evergrande building

As the debt-laden Chinese developer stands on the brink of collapse, the fallout poses risks across the financial system.

Fears that Evergrande, the massive Chinese real estate developer, is on the brink of collapse has sent shockwaves through global markets. The group suspended its shares on October 4 after missing coupon payments on two dollar-denominated bond tranches. With debts of more than $300bn, any fallout from the crisis will have serious repercussions for China’s financial system and economy.

The Shenzhen-based developer’s business model relied on a constant stream of short-term debt to develop properties and sell them years in advance of completion. But when the Chinese government stepped up its campaign against leverage this year, limiting developers’ capacity to accumulate debt, Evergrande found itself in trouble.

“An Evergrande failure in itself would not destabilise the [Chinese] banking system. However, if such an event were followed by the defaults of a few more highly leveraged major developers, it could evolve into a challenging situation,” according to an S&P Global report entitled ‘Credit FAQ: Evergrande default contagion risk ripple or wave?’.

Two fifths of banking system assets in China were directly or indirectly associated with the property sector by the end of last year, according to Citigroup.

The high degree of diversification and sizeable capital buffers at China’s large state-owned banks should insulate them from serious risk, according to Alicia García Herrero, chief economist, Asia-Pacific at Natixis. “However, smaller banks are more exposed,” she says.

The worst-case scenario outlined in a recent People’s Bank of China stress test on banks’ exposure to the property sector pointed to a 15 percentage point increase in developers’ non-performing loan (NPL) ratios and a 10 percentage point rise in the housing NPL ratio, which would reduce the banking sector’s overall capital adequacy ratios by 2.1 percentage points, to 12.3%, according to S&P Global.

Direct and indirect exposure

Chinese banks’ direct and indirect exposure to Evergrande — including its wealth management products, which some banks helped originate — stood at about Rmb400bn ($62bn) as at the end of June.

Shengjing Bank, for example, has significant exposure to the group and the already stretched bank would “likely bear more strain” should Evergrande default, according to S&P Global. China Minsheng Bank is another one Evergrande’s chief credit sources, although it has been cutting its exposure to Evergrande over the past year. Fuzhou-based Industrial Bank has also said it had gradually reduced exposure to Evergrande.

When the shadow banking system comes into play, it becomes more complicated to predict how the situation will play out

Eiko Sievert, Scope Ratings

“Banks have been aware of potential difficulties with Evergrande for some time and many have already taken appropriate action,” says Eiko Sievert, an analyst at Scope Ratings. This reduction in exposure can be seen a drop in Evergrande’s borrowings, which fell from Rmb604bn at the end of 2019 to Rmb507bn at the end of 2020.

China Zheshang Bank’s outstanding loans to Evergrande total Rmb3.8bn, while China Everbright Bank has lent the distressed developer Rmb5.4bn, according to Bloomberg.

Evergrande has also relied on China’s vast shadow-banking system. About 45% of its interest-bearing liabilities in the first half of 2020 were from trusts and other shadow lenders, according to researcher Gavekal. “When the shadow banking system comes into play, it becomes more complicated to predict how the situation will play out,” Mr Sievert says.

Offshore risks

The offshore bond market is another of concern. Mainland Chinese developers are the largest issuers of dollar-denominated bonds traded in Hong Kong, and Evergrande has been the single largest issuer.

Credit Suisse, which helped arrange $4.6bn of dollar bonds for Evergrande over the past decade, sold down its entire exposure to the developer late last year. “Early indications suggest that European or UK banks direct exposure Evergrande is not that material,” Mr Sievert says.

HSBC, which had $17bn in exposure to Chinese real estate at the end of June, has had holdings of $200m in Evergrande’s dollar bonds, according to Bloomberg. The bank’s asset management arm announced plans to close its HSBC Global Income Bond Fund on October 5 following widespread sell-offs of China's high-yield debt. HSBC did not respond to requests from The Banker for comment.

“Other Chinese property developers are likely to go under,” warns Louis Kuijs, head of Asia economics at Oxford Economics. “The problems with Evergrande have reminded creditors that lending to such companies can be risky. Financing costs for developers has gone up and this will cause others to have liquidity problems.”

Such a scenario raises the possibility of the crisis spreading. The Chinese property sector, including construction and other related industries, accounts for 29% of gross domestic product, according to a study by Harvard University and Tsinghua University.

A resultant slowdown in the world’s second-largest economy would have implications for financial institutions everywhere. “There are potential risks to the whole global supply chain from the Chinese property sector. However, the Beijing government has the capacity to contain those risks to a large degree, if it seeks to,” Mr Sievert adds.


All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker

For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Request a demonstration to The Banker Database

Join our community

The Banker on Twitter