I really enjoyed this post Professor. Because of how you broke down the reasons for Evergrande's potential default (ie. New home sales fell 19% in August, ICBC, median gross profit margin of Chinese property developers, total liabilities of CE = $300B, etc.).
It so interesting to hear your mental process of diagnosing and researching companies, especially when you break it down into steps. Keep up the good work! This newsletter continues to fuel my interest in finance, financial history, and the global economy!
Interesting and perceptive analysis. I agree with your observations - “.. a lot of coal… very large canary”. Clearly there is more in play here than a single company’s excessive leverage. That being said, I think the prospects for a China Lehman are very small indeed. A government with highly centralized power and vast financial resources has the ability to manage outcomes - for better or worse - and China’s current leadership has demonstrated their competence and willingness to do so (sometimes ruthlessly). My expectation is that they will use Evergrande and similar cos to teach painful lessons to lenders - probably more so for international lenders and less for domestic - but spare the other creditors (trade liabilities, including especially customer down payments). At the end of the day Chinese leadership values domestic stability above all other objectives, as it is that which could threaten the CCP. Their decisions on Evergrande, as with most other issues, will be assessed through that prism.
Thanks Craig. I always appreciate your thoughtful comments. This is a particularly interesting situation, and a good prompt for me to learn more about China. Best, Carl
Carl: Great summary of the Evergrande situation. I suspect, as you articulate, the mostly likely outcome will be a "kick the can" back door government arrangement that will attempt to stabilize the financial distress and provide ongoing liquidity. Unlike financial institutions, Evergrande as a property developer does not have readily marketable assets that can be easily securitized, posing a more difficult restructuring challenge than the 2008-2009 U.S. bank crisis. Simply stated, the nature and liquidity of Evergrande's assets are not "matched" with the capital structure of the company. Historically, western banks have been loathe to lend to property developers, and for good reason. When one considers the contagion risk among lenders and the "back-leverage," or borrowings, of trade creditors and home buyers who made substantial deposits for future delivery of homes, a domino-like debt crisis could result. Perhaps a remote, black swan event, and likely contained largely within the Chinese economy. The lesson for offshore buyers of dollar denominated Chinese debt who have chased yield is to remind oneself that there was a reason why the interest rates on the debt were so attractive.
I really enjoyed this post Professor. Because of how you broke down the reasons for Evergrande's potential default (ie. New home sales fell 19% in August, ICBC, median gross profit margin of Chinese property developers, total liabilities of CE = $300B, etc.).
It so interesting to hear your mental process of diagnosing and researching companies, especially when you break it down into steps. Keep up the good work! This newsletter continues to fuel my interest in finance, financial history, and the global economy!
Interesting and perceptive analysis. I agree with your observations - “.. a lot of coal… very large canary”. Clearly there is more in play here than a single company’s excessive leverage. That being said, I think the prospects for a China Lehman are very small indeed. A government with highly centralized power and vast financial resources has the ability to manage outcomes - for better or worse - and China’s current leadership has demonstrated their competence and willingness to do so (sometimes ruthlessly). My expectation is that they will use Evergrande and similar cos to teach painful lessons to lenders - probably more so for international lenders and less for domestic - but spare the other creditors (trade liabilities, including especially customer down payments). At the end of the day Chinese leadership values domestic stability above all other objectives, as it is that which could threaten the CCP. Their decisions on Evergrande, as with most other issues, will be assessed through that prism.
Thanks Craig. I always appreciate your thoughtful comments. This is a particularly interesting situation, and a good prompt for me to learn more about China. Best, Carl
Carl: Great summary of the Evergrande situation. I suspect, as you articulate, the mostly likely outcome will be a "kick the can" back door government arrangement that will attempt to stabilize the financial distress and provide ongoing liquidity. Unlike financial institutions, Evergrande as a property developer does not have readily marketable assets that can be easily securitized, posing a more difficult restructuring challenge than the 2008-2009 U.S. bank crisis. Simply stated, the nature and liquidity of Evergrande's assets are not "matched" with the capital structure of the company. Historically, western banks have been loathe to lend to property developers, and for good reason. When one considers the contagion risk among lenders and the "back-leverage," or borrowings, of trade creditors and home buyers who made substantial deposits for future delivery of homes, a domino-like debt crisis could result. Perhaps a remote, black swan event, and likely contained largely within the Chinese economy. The lesson for offshore buyers of dollar denominated Chinese debt who have chased yield is to remind oneself that there was a reason why the interest rates on the debt were so attractive.