EverGrande

China's Lehman moment?


China’s Lehman Brother’s moment. That’s what the headlines say, but is it?

Background:

China’s Real Estate market, construction, and surrounding industries make up a supply chain that accounts for more than a quarter of Chinese economic output.1 The vast majority of the Chinese people and middle class have used Real Estate as an investment tool rather than stocks due to the restrictiveness of the CCP. Chinese household debt has ballooned to 62% from 39% of GDP since 2015, largely through residential mortgages.

Ghost cities were not just a result of its people, it came from the top. The Federal and Local governments around China tried to juice and stimulate their economies by building more infrastructure and stimulating the property market.2 All of this created the perfect storm and unintended consequence of “Ghost Cities” or brand new empty cities in various parts of China.

It should be noted that all Chinese metrics should be taken with a grain of salt due to their consistency with misreporting.

Evergrande is China's second-largest property developer. It is also the most indebted property developer in the World with liabilities totalling 310 billion dollars. Larger than the gross national debt of New Zealand.3 It currently holdings are 231 million m sq of real estate. (Or 4 Manhattan's combined). A number which could house the entire population of Portugal.

Evergrande relies upon downpayments of its customers to fuel is growth, along with debt, equity sales and the future growth/valuation of its product.

China's central bank the People Bank of China (PBOC) highlighted in 2018 that companies including Evergrande might pose systemic risks to the nation's financial system.

China then implemented new regulations and guidelines banning developers from selling unfinished properties have put an end to pre-sales that Evergrande largely used to finance itself and keep its activities afloat. Dubbed: the Three Red Lines. Evergrande did not manage to reach all three.

Concerns were further raised when a leaked letter (possibly fake) last year said Evergrande's liabilities involve more than 130 banks and over 121 non-banking institutions. JPMorgan estimated last week China Minsheng Bank one of the largest banks in China has the highest exposure to Evergrande.

The leaked letter, along with the pandemic decimated Evergrande.

Evergrande is now considered a junk bond and Moody’s downgraded them to a CCC rating.

Evergrande between a rock and a hard place is now offering varying schemes to repay its investors: 10% in cash of investment value for the next 2.5 years; or offering undeveloped property at firesale prices (their preferred scheme). As they have developments totalling ¾ the size of Manhattan unfinished. The firesale prices are: 28% off housing, and 46% commercial.

Given they have little actual capital and most seizable assets are under construction people have taken to protesting outside their various offices, for else they are powerless.


Analysis:

Repayments are coming due next week. Monday is a key date for repayment. Evergrande has warned don’t expect those payments. A fair portion of Evergrande’s debt is due within a year and that has scared both investors and governments.

Late payments or defaults could trigger cross-defaults as many financial institutions have exposure to Evergrande via direct loans and indirect holdings through different financial instruments. Further any skittishness caused by Evergrande may cascade into other parts of the Chinese real estate market and beyond.

In the dollar bond market, Evergrande accounts for 4% of Chinese real estate high-yields. Any defaults may trigger sell-offs in the high-yield credit market.

A collapse of Evergrande will have a large impact on the job market, as Evergrande has 200,000 staff and hires 3.8 million people every year for project developments. This significant loss within China will trigger a recession within China and would cascade globally, as various suppliers and manufacturers default.


The Two Outcomes:

Outcome One:

The CCP specifically the PBOC decides not to intervene in the poster child of an over-leveraged company and have junk bonds/debts on their books; deciding to take a wait and see approach. Evergrande with it’s newly hired debt consolidators do an amicable job, but it’s not enough. It’s a tourniquet and Evergrande becomes the first of many dominos to fall as the market loses confidence.

Outcome Two:

Come Monday or perhaps sooner the CCP announces the State support/absorption of Evergrande, such as a debt for equity program to support its citizens and prop up the economy; the market rallies 3% despite the continued systemic risk, and we carry on this clown world.

Both are just as likely, It’s a Clown World

¯\_(ツ)_/¯

1
https://www.barrons.com/articles/china-evergrande-property-problems-51631815303
2
https://www.abc.net.au/news/2018-06-27/china-ghost-cities-show-growth-driven-by-debt/9912186
3
While indeed Evergrande’s debts easily total more than 80+ billion, after their potential sale of assets (assuming not a complete collapse in pricing) their debts would still loom over New Zealand.