Why China Evergrande's default matters?

China Evergrande, once China's second largest property developer is on the brink on default and has been in the international news, causing huge market volatility in China and Hong Kong's stock market. The potential default will likely be one of China's biggest test in the financial markets.

Ever since China has been clamping down overleveraged corporations such as HNA and Dalian Wanda, China Evergrande has not been spared as well.

Since Aug 16 till 15 Sep, China's developers lost between 15-50% in market value.

After going on a debt fuel expansion, China Evergrande amassed a total debt of US$300bil, which is the world's most indebted property developer, amounting to nearly 2% of China's GDP. Now the whole world is concerned whether China Evergrande will be the 'Lehman Brothers' of China.

Here's who will be affected.

1.Banks

The banks will be the first to be hit if the default happens. As we can see, the bulk of the borrowing came from the banks and its related channels, amounting to US$79.3bil. As China Evergrande is busy offloading its unsold property units to its investors and other creditors, it will inevitably cause home prices to plummet. Usually banks will extend a secured credit line to developers with their properties or other assets as collateral, it will very likely mean that after the asset dropped in values, the banks will unlikely able to recover the full amount.

With the banks having such exposure, the market is worried that a potential bank run might happen and trigger a chain effect in the banking industry like the Lehman Brothers.

2. Institutional Investors

While it's offshore bonds stands at US$20.7bil, most of the offshore bonds are being held by institutional investors and will unlikely to get any monies back due to its WFOE structure.

3. Home buyers

China Evergrande has 1300 projects in 280 cities, with more than 600,000 apartments uncompleted. These are housing for around 2 million people and most of the buyers are ordinary people who took mortgages to purchase the properties.

For the ordinary home buyers, it might not be worthwhile serving the mortgages and might choose to default on the mortgages. in the event of a default and a massive sell off real estate, it might trigger a widescale default of mortgages which might erupt into a mortgage crisis like in the 2007-2008 which were triggered by large amount of defaults by the subprime mortgages.

4. Investors of its wealth products

China Evergrande also sold structured wealth management products through banks after the government started to crack down on the overleverage by China corporations. These wealth products are similar products like the Lehman Brother's minibonds which promised high guaranteed returns. However, investors are unlikely to get back any monies from these products.

5. Suppliers

The suppliers are the amongst the group that might not get back their monies unless they have uncompleted projects with China Evergrande which they might be able leverage to get some money back. However, smaller suppliers and contractors are unlikely to get back any monies due to the lack of leverage and might even trigger bankruptcies and job losses at the SME market.

On the bright side of things, China Evergrande has quite a bit of assets to offload in order to raise cash to pay off creditors.

China recent sold of its stakes in Shengjing Bank to state owned enterprise for US$1.5bil. We could see more asset sale of China Evergrande in order to raise enough cash for repayment of interest and loans.

So far, the Chinese Government has not initiated any assistance to China Evergrande.

China Evergrande will need to raise at least US$8bil by next year in order to prevent a full fledge default.