Evergrande credit event in China could have wider effects

Many sectors could be exposed to increased credit risk if Chinese property developer Evergrande defaults, according to Fitch Ratings. We believe a default would reinforce the credit polarization among home builders and could cause difficulties for some smaller banks, although we believe the overall impact on the banking sector would be manageable.

Fitch demoted China Evergrande Group to “CC” from “CCC +” on September 7, indicating that we consider some default likely. Growing investor concerns over Evergrande’s creditworthiness have already exacerbated credit polarization among developers, leaving those with weaker credit metrics struggling to tap debt markets at sustainable interest rates. , thus increasing the risk of refinancing.

Evergrande is one of China’s top three developers, although the residential real estate market is highly fragmented. Evergrande’s market share in 2020 was only around 4%. We believe the risk of significant house price pressures in the event of a default would be low, unless the restructuring or liquidation of its assets becomes haphazard. Fitch thinks this is something the authorities will want to avoid.

We see the government’s priority in a default scenario as the completion of the sold projects of Evergrande. Debt associated with project companies is generally manageable, but we believe potential buyers will still want to avoid any negative impact on their operations – or their creditworthiness – given the industry’s stringent funding conditions.

Banks have direct exposure to loans and bonds at Evergrande, as well as exposure to off-balance sheet wealth management products, through fiduciary loans. The company’s liabilities in these areas were around CNY 572 billion at the end of 1H21, much of which we believe was held by banks and other financial institutions. Banks may also have indirect exposure to Evergrande suppliers – the developer’s trade debts were CNY 667 billion. Small banks more exposed to Evergrande or other vulnerable developers could face a significant increase in Non-Performing Loans (NPLs), depending on the development of any credit event involving Evergrande.

A recent sensitivity test by the People’s Bank of China indicated that while the ratio of non-performing loans to home loans increased by 15 points and that for loans 14.4%. (This stress level is way above what we would expect from a single Evergrande fault.)

Growth in residential mortgages and bank property development loans slowed in 1H21 following the introduction of new regulatory ceilings in January 2021. -single-digit growth or a decline in mortgage lending in general. Our basic assumption is that this trend would not be affected by an Evergrande default as banks continue to limit exposure to the real estate sector in order to meet regulatory requirements.

At the macro level, an Evergrande default could hurt consumer confidence if it were to affect household deposits for homes that have not yet been completed, but we assume the government would act to protect household interests. , which makes this outcome unlikely.

In the unlikely event that a default disrupts the housing market as a whole, significantly disrupting sales and investment, it could have wider macroeconomic effects. We estimate that the sector represents around 14% of the GDP. Risks to our growth prospects in China are mitigated by the government’s ability to intervene with policies to support the housing market, but we believe the threshold for such support will be high, as it could delay other priorities such as reducing home loans. concentration and fight against the high cost of housing. Other forms of stimulation to support economic growth would also be possible in this scenario.
Source: Fitch Ratings

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