Global Markets on Edge as China's Mammoth Property Firm Inches Closer to Collapse

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China Evergrande Group, once China's top-selling property developer, inched closer to a key deadline where it risks a default on its bonds, but world markets were calmer as investors and analysts played down the threat of its troubles becoming the country's "Lehman moment."

While concerns about the spillover from a messy collapse roiled markets on Monday, U.S. stocks were flat on Tuesday. The U.S. dollar held relatively steady and the U.S.'s corporate bond market steadied.

Possibility of Contagion

"There's been a fair bit of concern about the possibility of contagion from the meltdown at Chinese property developer Evergrande," analysts at New York-based Bespoke wrote in a research note on Tuesday. "But so far that concern isn't showing up in parts of the credit markets that have served well as red flags for broader credit crunches in the past."

China property market
China property prices are expected to fall in 2017 Reuters

A major test for Evergrande comes this week, with the firm due to pay $83.5 million in interest relating to its March 2022 bond on Thursday. It has another $47.5 million payment due on Sept. 29 for March 2024 notes .

Both bonds would default if Evergrande fails to settle the interest within 30 days of the scheduled payment dates.

Missed Interest Payments

Evergrande missed interest payments due Monday to at least two of its largest bank creditors, Bloomberg reported on Tuesday, citing people familiar with the matter. The missed payments had been expected as China's housing ministry had said that the company would be unable to pay on time, Bloomberg said.

As investors and policymakers around the world tried to assess the potential fallout, Securities and Exchange Commission (SEC) chair Gary Gensler said the U.S. market is in a better position to absorb a potential global shock from a major company default than it was before the 2007-2009 financial crisis.

Teenager dies while playing 'the floor is lava'
Representational image of a down-view from a high-rise building Pixabay

Fed Chair Jerome Powell will likely be asked about the fallout from Evergrande when he speaks after the Fed's two-day meeting that wraps up on Wednesday at 2 p.m. ET.

Despite the looming default, some funds have been increasing their positions in recent months. Fund giant BlackRock and investment banks HSBC and UBS have been among the largest buyers of Evergrande's debt, Morningstar data and a blog post showed.

Other bondholders include UBS Asset Management and Amundi, Europe's largest asset manager.

Messy Meltdown or Managed Collapse?

In any default scenario, Evergrande, teetering between a messy meltdown, a managed collapse or the less likely prospect of a bailout by Beijing, will need to restructure the bonds, but analysts expect a low recovery ratio for investors.

S&P Global Ratings said on Monday it believed the Chinese government would only act in the event of a far-reaching contagion posing systemic risks to the economy.

"I would characterize Evergrande as a telegraphed and controlled detonation," said Samy Muaddi, the portfolio manager of the $5.1 billion T. Rowe Price Emerging Markets Bond fund, who does not have a position in the company.

China stocks
An investor is seen in front of an electronic screen showing stock information at a brokerage house in Beijing, China, January 27, 2016 Reuters

BNP Paribas estimated in a research note that less than $50 billion of Evergrande's $300 billion outstanding debt is financed by bank loans, suggesting the Chinese banking sector will have a sufficient buffer to absorb potential bad debts.

Citigroup Inc subsidiaries serve as trustee and payment agent for a China Evergrande bond that matures in March 2022 and has $83.5 million in interest coming due on Thursday.

"We do not have any direct lending exposure to Evergrande; our indirect exposure through counterparty credit risk is small and with no single significant concentration," Citigroup spokesperson Danielle Romero-Apsilos said in an email on Tuesday. She declined to comment on Evergrande's scheduled payments.

Battered Confidence

In an effort to revive battered confidence in the firm, Evergrande Chairman Hui Ka Yuan said in a letter to staff that Evergrande will fulfil responsibilities to property buyers, investors, partners and financial institutions.

Mainland China's stock and bond markets, foreign exchange and commodity futures markets, which were closed Monday and Tuesday for Mid-Autumn Festival, resume trade on Wednesday, but Hong Kong's financial markets will be closed for a public holiday.

Evergrande's shares fell as much as 7% on Tuesday, having tumbled 10% in the previous day, on fears its $305 billion in debt could trigger widespread losses in China's financial system in the event of a collapse. The stock ended down 0.4%.

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