The seasoned trader has ridden roller coasters like this before. Knowledge on the spread of the contagion from the Evergrande default is slim. I’m not well versed in extracting data from China like I am the US. Also, I don’t have a bloomberg terminal, which makes it more difficult to source the data on the Evergrande bondholders. From what I can come up with, there are two concerns afoot. The first is Evergrande’s default. The second is the ability of Evergrande’s suppliers to afford to not be paid.
On the first point, Evergrande has $305 billion in liabilities. Of these liabilities, $89 billion is held by banks and other financial institutions. Unfortunately, some of these same banks could be exposed to Evergrande’s suppliers. This is how the contagion could spread.
I found some old data (2016) on Chinese bank’s loan exposure. It details the top four banks.
These banks have half or better of their capital tied up in loans. Some of these loans will be residential, some will be commercial, and others will be industrial. It is practically a guarantee that all four of these banks are holding Evergrande bonds or loans.
I see three paths out of this mess. The first is that China’s central bank bails out Evergrande and kicks the can down the road. While this is what investors are hoping for, I feel there is less than a 10% chance this would happen. There are two reasons for this. The first is that the CCP watched the US meltdown over housing 13 years ago and do not want to follow the same path. The second is that Xi does not feel threatened by Evergrande defaulting. The people of China are angry at Evergrande, not at the government. If the people began petitioning the government to “do something”, the chances that a bailout would happen would grow.
The second path is a structured default by Evergrande. Lenders and suppliers would be brought together to discuss new loan terms. Shareholders would be wiped out. Bondholders would lose money but not everything. There may even be special loans from the central bank to help sweeten the deal. I think this is the most likely scenario. I put the odds at 70%. This would take time to play out. Several months at a minimum to get everyone to the table and talking realistically. Once it becomes obvious that this would happen, the markets would no longer hinge on every word coming out of a Chinese official.
The third path is a structured bailout. Evergrande would go under and shareholders would be wiped out. The banks that loaned Evergrande money would be bailed out. This would make them whole and the contagion effect would die. I only put this at 20% odds. The banks would not have any caution about making risky loans if they anticipate being bailed out. This is the exact situation the US is facing and China doesn’t want to repeat these mistakes.
The ironic point in all this is that China would be taking a more free market approach than the US did. Bailout programs are inherently socialistic. They reward those close to government power and harm the citizens but they are sold to the public as being in the average citizen’s best interest.