Lesson 5.2 · 2 of 5 · Red flags
Short-term debt risk: lessons from Lehman and Evergrande
Short-term debt turns dangerous when a company borrows for days or months to hold assets that are hard to sell, and lenders stop rolling the loans over. You check it with the current and quick ratios, cash against short-term debt, and the maturity table in the notes.
Terms in this lesson
- Current ratio
- Whether the company has enough cash and quick assets to pay its bills for the next year.
- Quick ratio
- Whether a company can pay its short-term bills without selling its inventory.
- Leverage
- You invest more than you have, with money borrowed from your broker.
- Net debt
- The company's financial debt minus the cash it holds.
Why funding long-term assets with short-term debt is risky
Definition
Where does the risk come from?
You borrow for days or months, but the money is tied up in assets that are hard to sell or only pay back over years.
Picture a property developer that takes one-year loans to put up blocks of flats it will finish and sell in three years. As long as the banks keep renewing the loans, all is well. If one year they refuse, the developer has to pay before the flats are sold. The problem is not necessarily that the assets are worthless, but that they cannot be turned into cash in time. This is refinancing risk, and leverage makes it worse: the more borrowed money a company works with compared with its own, the smaller the loss needed to wipe out its equity.
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Create a free accountLehman Brothers: leverage and Repo 105
Lehman Brothers was a US investment bank. On 30 November 2007, the end of its financial year, it had assets of about $691bn and shareholders’ equity of $22.5bn: leverage of 30.7 times. In the same year it had reported record net income of $4.2bn.
Definition
What was Repo 105?
Short-term loans secured on securities that Lehman booked as sales, just before each reporting date.
A repo is a loan for a few days: you hand over securities as collateral, receive cash and agree to buy the securities back. Normally the securities stay on your balance sheet. With Repo 105, Lehman handed over at least $105 of securities for every $100 received and treated the deal as a sale. It used the cash to pay down other debt, so the balance sheet looked smaller at quarter-end. The report by examiner Anton Valukas, filed in the bankruptcy case, puts the figure at $38.6bn in November 2007 and $50.38bn in May 2008, at the quarter-end closes. Lehman could not find a US law firm to back sale treatment and relied on an opinion from the London firm Linklaters. The examiner found there was a case to answer (a “colorable claim”) of professional malpractice against the auditor, Ernst & Young; his report is not a court ruling.
Lehman’s net leverage at the quarter-ends of November 2007, February 2008 and May 2008: reported 16.1, 15.4 and 12.1 times; without the Repo 105 deals, 17.8, 17.3 and 13.9 times, according to the Valukas examiner’s report.
In the months before the collapse, the banks that cleared Lehman’s trades, JPMorgan and Citibank, asked it for billions of dollars in collateral. On 10 September 2008 Lehman reported a liquidity pool of $41bn; by 12 September it had less than $2bn of assets that could readily be turned into cash, the examiner said. On 15 September 2008 it filed for Chapter 11 bankruptcy protection in the US Bankruptcy Court for the Southern District of New York. Lehman put its assets at $639bn and its debts at $613bn, as of 31 May 2008.
Evergrande: how a property developer ended up being wound up
Real case
China Evergrande, from the “three red lines” to liquidation
On 20 August 2020 Chinese regulators set three limits for big developers: liabilities of no more than 70% of assets (excluding buyers’ advance payments), net debt below equity, and cash at least equal to short-term debt. At 30 June 2020 Evergrande breached all three: 83%, 159% and a cash to short-term debt ratio of 0.6. In September 2021 it missed two interest payments on offshore bonds, totalling $131m. It reported net losses of 476bn yuan for 2021 and 105.9bn yuan for 2022. On 29 January 2024 Madam Justice Linda Chan of the Hong Kong High Court ordered it to be wound up, and on 25 August 2025 its shares were removed from the Hong Kong stock exchange.
The liquidators said the $45bn of claims was not a final figure and that so far they had sold only about $255m of assets. A developer’s assets, land and half-built blocks, are real enough, but they sell slowly and at steep discounts just when the whole market is short of cash.
How to check short-term debt: liquidity ratios and maturities
What can turn into cash within a year, against what must be paid within a year.
Leaves out inventory, which is hard to sell in a crisis. Also called the acid test.
How much of the debt due next year could be paid from the bank account.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Lehman Brothers, results release of 13 December 2007 (Form 8-K, SEC EDGAR: assets $691bn, shareholders’ equity $22.5bn, leverage 30.7x); report of examiner Anton R. Valukas, vol. 3, section III.A.4, and his testimony to the US Senate; AP, 15 September 2008; Caixin Global, 25 September 2020; Reuters, Evergrande timeline (August 2025); CNBC, 28 August 2023; The National (Bloomberg), 29 January 2024; AP, 12 August 2025; Boeing, 10-K annual report for 2025, balance sheet at 31 December 2025.