Chinese banks brace for losses as Evergrande calculation looms

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HONG KONG – With $ 305 billion owed to banks, bondholders, trust companies, homebuyers, suppliers and contractors – plus an unknown amount of off-balance sheet liabilities largely owed to retail investors – who will perceive first if China’s Evergrande defaults?

That’s the question in Beijing and in the financial corridors of Hong Kong as the world’s most indebted real estate developer is on the brink of collapse. As for Chinese banks, the consensus is that they will have to take big losses, even if their size remains uncertain.

“It is not too difficult to sketch the outline of a possible solution,” said Wei He, Chinese economist at Gavekal Dragonomics. “The political priority will be to protect buyers who have paid Evergrande for housing but have not yet received the completed housing. If the households that bought the goods and the businesses that build them are protected, it is the financial institutions that will have to absorb the losses. “

Evergrande has 800 projects underway in China, with most of the apartments being fully paid. More than half of the projects were interrupted due to non-payment of contractors. Evergrande shares have collapsed 85% this year and its bonds are trading at 25 cents on the dollar. The company made a surprise announcement on Wednesday that it will make a bond interest payment on time on Thursday, but that’s only a fraction of the $ 850 million in total coupon payments owed this year.

Xu Jiayin, founder and chairman of Evergrande, said in a letter to staff on Tuesday that the company is confident it will meet its responsibilities to customers, investors and lenders. “I firmly believe that with your concerted efforts and hard work Evergrande will emerge from its darkest moment. [and] resume large-scale construction as soon as possible, ”he said.

Evergrande’s main lenders, led by China Minsheng Bank, have already put money aside to cover potential loan losses, according to two people familiar with the matter. The developer owes more than 128 banks and around 121 non-bank institutions money, according to a leaked letter Evergrande wrote to the government late last year.

Besides Minsheng Bank, the other companies most exposed to the developer are the Agricultural Bank of China, the Chinese Zheshang Bank, the Chinese Everbright Bank and the Chinese CITIC Bank. Shenjing Bank, controlled by Evergrande, was also among the top 10, which was owed a total of 127 billion yuan ($ 19.6 billion) as of June 30 of last year, according to the leaked letter.

Since then, banks have reduced their exposure, although none have released figures.

China Minsheng Bank is one of the main lenders in Evergrande.

Evergrande, which is due to make bond coupon payments on Thursday, is strapped for cash and has started offering vendors and retail debt investors discounted apartments, parking spaces and storefronts instead. missed payments.

So far, authorities have only summoned the leaders of Evergrande and told them to quickly reduce the debt. They have yet to reveal any bailout or resolution plans, nor have they flooded the market with liquidity like they have in the past during times of real estate market stress.

Reuters reported earlier this week that Minsheng Bank, CITIC Bank and two other major lenders from Evergrande were ready to roll over some of the developer’s short-term debt.

“We believe that regulators can buy time to digest Evergrande’s NPLs by guiding banks not to take credit and extend interest payment deadlines,” Citigroup analyst Judy Zhang said. “During the grace period, Evergrande will liquidate good assets, seek strategic investors such as state-owned companies, and seek to restructure debt, with the loss ultimately shared by the entire system, and financial institutions and investors. could reduce constituents. “

Citigroup estimates that Evergrande’s outstanding loans and bonds amount to only 0.3% of the banking system’s assets, but a default that hinders other developers’ access to credit would harm the banking system. He estimates that 40.7% of Chinese bank assets are directly or indirectly linked to the real estate sector, and any fall in real estate prices could have a ripple effect on the quality of banks’ assets.

The Citigroup study calculated that 17 Chinese banks had 675 billion yuan of exposure to risky developers, or 4.8% of their level 1 capital, which is a measure of a bank’s ability to absorb losses. futures. Minsheng Bank, Ping An Bank and Everbright Bank were the most exposed, he said, accounting for 27.1%, 12% and 9.2% of 2020 Tier 1 capital respectively, Citigroup said.

Analysts and investors believe the capital and loan loss buffers built by lenders will be enough to avert a systemic crisis; not only the fall of Evergrande but also any spillover into the rest of the real estate sector. Authorities were more cautious, however, with Guo Shuqing, chairman of China’s Banking and Insurance Regulatory Commission, calling real estate the biggest risk for China’s financial system late last year.

A critical question is whether Chinese banks have been cautious enough to prepare for an increase in bad debts. Commercial banks had provisioned 5.4 trillion yuan in loan loss provisions at the end of June 30, up 174.6 billion from the previous quarter. That brought the provision coverage ratio – that is, provisions relative to the current level of bad debts – to 193%, up 6 percentage points, according to regulatory data.

Matthew Chow, an analyst at S&P Global Ratings, said self-initiated lenders began reducing their exposure to Evergrande from May amid tighter liquidity and credit problems the company was facing. Nonetheless, the rating agency warned this week of possible contagion.

A People’s Bank of China sensitivity test released earlier this month showed that while the bad debt ratio for home loans increased by 15 percentage points, and for mortgages by 10 percentage points, the average ratio The capital adequacy of the 4,015 banks assessed would have fallen from 14.4% to 12.3%, which S&P described as “no small success.”

“Failure of Evergrande in itself would not destabilize the banking system,” he said. “However, if such an event were followed by the flaws of a few major high-leverage developers, it could turn into a difficult situation.”


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