US Stock Market Dives amid China’s Looming Property Market Crisis

The major US stock market indexes dived yesterday following the debacle of the once almighty Chinese real estate developer Evergrande Group (HKEX: 333) as rumors continue to circulate about a potential default on the company’s dollar-denominated debt.

The price of the tech-heavy Nasdaq 100 index led the losing scoreboard as it shed 321.3 points during the session for a 2.1% loss while the S&P 500 and the Dow Jones Industrial Average went down 1.7% and 1.8% respectively as well.

Notably, buyers showed up to pick up the pieces right before the close and managed to trim the extent of the bloodshed. However, this was still the worst session for the three broad market indexes since May this year.

The Evergrande situation in China has been compared by some analysts with the bankrupted American investment bank Lehman Brothers, which went down back in 2008 in the midst of the subprime crisis after regulators declined to bail out the company.

The fall of Lehman back then pushed the financial system to the brink of collapse and, even though Evergrande is an entirely different animal, its far-reaching tentacles make its fall a threat to the stability of some institutions involved with the company.

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Who is the most exposed to the debacle of Evergrande?

Last year, a leaked letter from China’s central bank indicated that a total of 128 financial institutions and 121 non-financial commercial companies had exposure to Evergrande.

Meanwhile, some of the foreign institutions that are reportedly holding the most dollar-denominated bonds from the Chinese developer include Blackrock, UBS, HSBC Holdings, and the UK-based Ashmore Group. In total, these foreign investors are said to hold around $7.4 billion in Evergrande’s bonds.

How the crisis started?

Prices and sales of both residential and commercial properties in China have been booming for a while and Evergrande’s management took advantage of the positive momentum the sector was experiencing to amass a significant amount of debt to finance future projects.

The problem for Evergrande is that growth in the demand for properties plummeted while the COVID-19 pandemic disrupted the company’s ability to complete its projects on time and that put significant pressure on its cash flows.

Data from China’s  National Bureau of Statistics shows the extent of the deceleration in both the commercial and residential property segments. The combination of a steadily decreasing demand and shut-down construction sites created the perfect storm for the highly indebted business.

What can be expected from Evergrande in the future?

According to an update from the management published on 14 September, Evergrande expects a continued decline in its sales in the following months amid current market conditions while the management team also cited negative media comments as a factor that is accelerating the downtrend as consumers have lost credibility on the company’s ability to deliver.

Some extreme measures have been taken to deal with the firm’s surmounting debt including the offering of incomplete properties to lenders and suppliers to repay a portion of the outstanding commitments. However, the company informed that no progress has been made on that front or in regards to the firm’s effort to sell some of its subsidiaries to improve its liquidity.

Evergrande’s electric vehicle venture (China Evergrande New Energy Vehicle Group) and an office building located in Hong Kong are some of the assets the company is currently attempting to sell. Meanwhile, two advisors have been appointed by the firm to help it navigate the current turmoil – Houlihan Lokey and Admiralty Harbour Capital.

A key date for the company is approaching as a couple of coupon payments on its dollar-denominated debt are due this Friday while three other payments are scheduled to take place next week as well.

Sources cited by multiple media outlets have stated that bondholders have already been informed about an imminent default and off-shore investors might be the last in line to collect.

So far, officials from the government have not stated if the Chinese Communist Party (CCP) will be stepping up to bail out Evergrande even though this seems to be the base-case scenario assumed by most institutional investors and financial services firms.

If the crisis is left unattended, its ripple effects could devastate China’s financial system and that is the reason why a scenario in which the government makes an example out of Evergrande – similar to what the US did with Lehman – is deemed as a highly unlikely one.

US stock market futures rebound ahead of key Fed meeting

So far this morning, US stock market futures are rebounding after yesterday’s sharp decline with the three major indexes jumping by around 0.7%.

Officials from the Federal Open Market Committee (FOMC) of the Federal Reserve are expected to give a speech tomorrow less than a month after their long-awaited Jackson Hole summit. Announcements regarding an upcoming tapering of the US central bank’s asset purchase program are expected to be made. Therefore, this meeting will be closely followed by market participants as well.

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