From the Notepad of the CIO: A Quick Look at Evergrande 

We compare the current events surrounding Evergrande to those seen during the Asian financial crisis and Russian financial crisis from July 1997 to November 1998 where U.S. equity market performance saw sharp selloffs only to recover to pre-crisis levels within a few months.

During the Asian event, from October 21st, 1997 to October 27th, 1997, the S&P 500 Index was down -9.8% and the Dow Jones Industrial Average Index was down -11.2%.  Both indices were back to pre-crisis levels by December 4th, 1997.  Subsequently, during the Russian event from July 15th, 1998 to October 8th, 1998, the S&P 500 Index was down -18.3% and the Dow Jones Industrial Average Index was down -16.3%.  Again, both indices were back to pre-crisis levels by November 23rd, 1998.

Key Takeaways
•In August 2020, Evergrande (ticker: EGRNF), the largest issuer of high yield debt in China, accounting for 16% of the total market, signaled it would likely miss an interest payment to debt-holders as early as January 2021. This was first reported in September 2020 and vehemently denied by the company at the time of publication. The default in 2020 was avoided due to $13B in concessions from a group of its investors.

• The concessions, while helpful, were the equivalent of “kicking the can down the road” as there are significant debt loads (including bank borrowings, senior notes, and other debt) of approximately $200B coming due through the end of 2022. More than half of the amount, or $119B, is related to property presales, trade payables, and other contractractual obligations. However, only $20B of the total amount due is offshore.

• The market volatility seen this week is largely a result of investors monitoring an upcoming interest payment of $84M due on September 24 as the company scrambles to raise funds. While the markets have feared contagion, many believe it is unfounded as expectations are that the Chinese government would likely step in and backstop the company not allowing it to fail. Investors are monitoring closely and comparing it to the Asian and Russian debt events during 1997-1998 when Long-Term Capital Management was bailed out due to its foreign debt default exposure during that same period.

• We would expect any fallout to be muted and short lived given the governmental backstops and somewhat limited exposure of U.S. investors. Furthermore, by comparison, in 2008 around the time of bankruptcy filing, Lehman Brothers had total liabilities in the range of $613B compared to Evergrande’s $293B as of December 2020.

Company Profile
• Real-estate developer founded in 1996, owning more than 1,300 projects in over 280 cities in China with projections for it to build close to 1.5 million individual properties as of June 2021.

• Outside of real estate it has conglomerate like exposure with divisions in electric vehicles, an internet and media production unit, a theme park, a soccer club and a mineral water and food company.

• With 200 offshore and 2,000 domestic subsidiaries, it has a balance sheet with ¥2T ($357B) in assets -- equivalent to 2% of China’s GDP, according to Goldman Sachs.

Comparison & Key Debt Metrics
• As of December 2020, with total liabilities of ¥1.95 ($293B), Evergrande is the most indebted company in the world with long-term debt of ¥630B ($95B) and much of the remaining ¥985M ($148M) of accounts payable & accrued expenses

• Debt due in less than a year = ¥240B ($36B)
• Total interest payments due in 2021= ¥5B ($699M)
• Cash & ST equivalents = ¥160M ($24M)
• Solvency Ratios: Total Debt/Equity 4.9x, Total Liabilities/Total Assets 82.7%
  

• For sake of comparison, notable U.S. company debt levels (as 12.31.20): General Electric $59B, United Airlines $34B, Ford Motor $25B, and Dow Chemical $15B

• Lehman Brothers balance sheet at its bankruptcy filing was around $613B with $164B in long-term debt.