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China’s Evergrande default risk weighs on global markets — here’s why

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Yahoo Finance's Brian Cheung takes a look at China Evergrande Group and its role in this week's major market sell off.

Video Transcript

BRIAN SOZZI: OK, as we mentioned, the situation with China property developer Evergrande is dominating market sentiment globally today. Yahoo Finance's Brian Cheung is here with a look at whatever 'grandes problems are and what may happen next. Brian.

BRAN CHEUNG: Well, Brian, obviously, a lot of attention on the price action in Evergrande shares, especially with the spinning, tumbling, I guess, indexes that we've seen in the East Asian markets. But we need to unpack exactly what is going on here. Evergrande, this big real estate conglomerate based out of China.

It's not just real estate, they have an electric vehicle arm. At one point, they also owned a soccer team in Guangzhou. They were at many times during their lifespan in the grain, dairy, mineral water business. But the real concern is the amount of debt that they had piled up through a lot of those types of business expansions. And one concern is that they simply won't be able to pay back a lot of those bills.

And It's as soon as maybe this Thursday, when we'll get a picture of how debt-saddled they really are. The interest is really in these-- $80 million or so in interest that it has to pay on a five-year dollar bond that's due on Thursday. And on the same day, Evergrande is going to have to pay about $36 million to pay a coupon on an onshore bond.

So it's about $100 million or so that they're going to have to pay this week. But that's only a drop in the bucket when you consider that this is a company that has, in the aggregate, over $305 billion in debt. So again, they might not be able to pay this $100 million just this week. Calls into question the contagion that could happen if the overall $305 billion in debt that this company has ultimately goes unpaid to the many bondholders that are out there, not just in China, but also in the world.

Now, the concern now is how they're going to be-- how are they going to be able to repay this. Of course, we've seen the Chinese government not necessarily step in to bail them out right now. So it seems like they've been trying to mitigate these measures on their own. We've heard over the weekend that as far as the real estate business side of things, they're trying to repay a lot of their investors through discounted real estate. The success or the uptake of that program is yet to be seen.

And we've actually heard anecdotes from "New York Times" reporting that actually says they've been asking their own employees for loans to the company. And they say that it's really a way to preserve your bonus. If you work for Evergrande and you want to keep your bonus, they were asking you to provide a personal loan to the company. Obviously, from a strategic standpoint, really underscoring just how debt debt-saddled and desperate they are to try to repay a lot of these bills.

But we'll see, obviously, because of the fact that we won't get this type of information in terms of the way that they paid back these bills until later this week, we could be set up for a lot of interesting headlines that could be presenting further downside risk, at least to the end of this week, guys.

EMILY MCCORMICK: Brian, I'm wondering what position is the Chinese government in right now, in terms of whether or not to offer a lifeline at this juncture, because you mentioned the risk of contagion here? At the same time, we do have the central Chinese government trying to increase regulation of the property sector and not necessarily condone this type of elevated borrowing by real estate companies. But what kind of position is the government in right now given, again, this risk that we could see some fallout from potential default here?

BRAN CHEUNG: And, Emily, this is the major question and one big reason why I think you're seeing markets react so sourly to the headlines that we saw over the weekend and that we might see over the course of this week is it's unclear to what degree the Chinese government will come to rescue this troubled firm.

And I think that when we talk about the moral hazard that could come from bailing this company out, even the CCP is not necessarily too eager to want to save them and that's simply because they might want to send a message to an economy that's been trying to deleverage over the past few years that this type of debt-saddled business model isn't necessarily a recipe for success.

Now, of course, the other side of that coin is making sure that you don't have the failure of what could be a systemic organization that can not only ripple through the Chinese economy and lead to a drag-on output, but also ripple through, perhaps the global economy. So the Chinese government walking a bit of a tightrope here. We'll see how closely they are watching the debt payments later this week.

But what's also interesting is just how this might change the regulatory structure in China. This is not a bank or a financial services firm at the top level and it was unclear, maybe because of their weird conglomerate structure, where they had their arms stretching into so many different types of industries, who was the primary regulator that was responsible for making sure that this type of thing didn't happen? It might be a cautionary tale for other large conglomerates, which there are a lot of in China in the years to come.

BRIAN SOZZI: Brian, I just got a good note from Peter Boockvar over at Bleakly. And as our Fed guy, I think you'd appreciate his note here. He said, quote, "Let's not miss the big picture macro of a world that has gorged on debt with the help of cheap and easy money."

Now what's going on with Evergrande, I mean, it can apply to many other property developers here in the US, others in China. And in many respects, this is a byproduct of globally low interest rates by various central banks.

BRAN CHEUNG: Yeah, and especially in the real estate sector. And I think that's one big reason why we didn't see the Hang Seng index go down by 3% just because, singularly, of Evergrande. We saw a number of other real estate businesses that aren't nearly as leveraged fall as well. When you take a look at Henderson Land, that went down by 13%. Sun Hung Kai properties went down about 10% in the market. These are Hong Kong-based or Hong Kong-listed rather, real estate developers.

Now, of course, the concern is that it's really easy money and low interest rates that have allowed real estate properties to become so hot. There's a lot of interest in them and a lot of kind of parallels that are being drawn to the 2007, 2008 financial crisis. Now, of course, your housing markets are going to look very different in China than they are in the United States.

One big reason is because the nature of who's buying up these properties. Another big reason is because of the way that property is even hit the market. In the United States, it's very much a private-driven process, although, obviously, you do have the government with Fannie Mae and Freddie Mac, ensuring the ability and the liquidity of 30-year mortgages.

But in China, it's a completely different type of situation, because private ownership of land is very much a different story, especially given the CCP, the kindness structure over there in China with regards to who can legally own land, and when there is land available, how ultimately private developers are able to get a hand on that. It's very much a government-driven process and not one that can necessarily be considered a true democratic auction.

So I think these are definitely salient points to make about the relevancy of low interest rates to the booming housing markets but not necessarily or that fair to compare what's going on in the United States housing market to what's going on in, say, the European housing market and then, of course, over to Chinese markets as well. So it seems like, yes, global interest rates may have had a part in that but maybe not necessarily a driving factor here.

BRIAN SOZZI: Some real good points. Brian Cheung, thanks so much.