The Hong Kong market was Asia's largest loser on Friday, with investors fretting over likely defaults at property developers China Evergrande Group (HK:333 and EGRNY) and Kaisa Group (HK:1638). That dragged the Hang Seng index down 1.1%.
The Fitch ratings agency downgraded both developers to "restricted default" on Thursday. The two developers are the largest holders of offshore U.S.-dollar bonds, as they've issued around 15% of the total. Such high-yield bonds were once a staple way of boosting returns but have become highly risky, with several smaller developers already defaulting and unable to pay back principal not to mention interest.
The move by Fitch represents the first time Evergrande has been in official default and comes after a 30-day grace period expired on Monday for coupons on US$1.235 billion in bonds for the Evergrande subsidiary Tianji Holdings. Kaisa failed to repay the principal on US$400 million in senior notes that came due on Tuesday. There's no grace period for that failed repayment, Fitch said.
The developers themselves have gone silent about what's going on. Fitch says both companies have not responded to its request for any confirmation that the payments were actually made. The "restricted default" label means they have an "uncured payment default" on a "material financial obligation" but have not yet entered into bankruptcy, administration or liquidation, and continue operating as developers.
Because Tianji is a restricted subsidiary of parent Evergrande, Fitch said a default there triggers cross-default on Evergrande's bonds. Holders of the group's other U.S. dollar notes will see the debt come due immediately and the bondholders can request accelerated payment if at least 25% of the holders agree to request such payments. Evergrande has total debts of US$305 billion, according to its last official tally.
Evergrande would like to pretend it doesn't make bricks and mortar. Hui Ka-yan, the company's founder, said in October that electric vehicles would become the group's main business within a decade as it scales down development. If you go to the group's homepage, you'll see a picture of a car front and center, buildings in the background, and a first piece of news that the company's debut Hengchi car test model is due to roll off the assembly line "early next year."
I have an engineer friend here in Hong Kong who doubts Evergrande will ever produce electric vehicles. It has promised to deliver its first saleable cars early next year. However, it has been exceptionally slow in getting factories built and running and has attempted to buy expertise rather than developing its own intellectual property on vehicles. Shares in its spinoff Evergrande New Energy Vehicle Group HK:0708 seem to reflect that skepticism. They are down 90.4% in the last six months.
Still, Hengchi says it has developed prototypes for five production models. The new-energy group's president, Liu Yongzhou, says it is in a "three-month battle" to enter mass production.
Developer Evergrande previously dodged default three times, announcing that it made last-minute payments on the same day that a 30-day grace period was due to expire. It has made no such declaration about its latest past-due instalment, a US$82.5 million interest payment, where the original amount was due 30 days ago as of Monday.
Shares in Evergrande, China's largest developer by sales in 2020, are down yet another 1.7% here on Friday. That brings their precipitous six-month decline to 84%.
Kaisa asked for a suspension in its shares on Wednesday, pending market-moving news that has yet to come. They have yet to resume trading but are down 72% over the course of the last six months.
Liquidation in the offing?
Fitch assumes both Evergrande and Kaisa will be liquidated in bankruptcies if lenders are to recover their debts. This would result in substantial discounting of their property assets, both under-construction projects and properties they own and rent, as they are sold off.
Priority in any bailout likely will be given to completing the property projects. That's because many buyers have put down deposits on apartments and are angry that they may lose out. The Chinese Communist Party values "social stability" above all else, because stability secures the status quo and keeps the revolutionary party in power. But Chinese regulators, who have quickly come forward to say they're acting to ensure there's no systemic risk to the financial system, have also stressed the importance of paying back offshore creditors.
Evergrande did declare late on Monday that it has formed a risk-management committee that "will play an important role in mitigating and eliminating the future risks of the Group." The committee includes representatives from the province's asset-management arm Guangdong Holdings as well as the state-owned developer Yuexiu Property HK:0123. The government of Guangdong Province, where Evergrande is based, had already stated it had sent a "working group" to the company to supervise its rescue efforts.
The government also called in Evergrande's founder, Hui, for an interview. Evergrande admitted a week ago that in its current condition there is "no guarantee" it can fulfill its financial obligations. The central bank has labeled this matter a private-sector problem, and the Communist authorities suggest Hui dip into his US$9.1 billion personal fortune to paper over the cracks.
It's a day when the Pacific is awash with a wave of red. Every major exchange is lower, with the Topix in Japan down 0.8% and Australia off 0.4%. Investors are concerned about the economic disruption to trade-dependent Asia from the Omicron variant as well as prospects for inflation.
Only the tech- and export-oriented South Korean market (down 1.1%) matched the magnitude of the slide in Hong Kong. In mainland China, the CSI 300 index of the largest stocks ended down 0.5%. The Taiwan market also fell 0.5%.
The Hong Kong market is now down 16.9% in the last six months. It is at the confluence of the pressures on U.S.-listed or overseas-leaning Chinese companies and also has a hopeless puppet government that enjoys extremely little public support. For that reason, it is holding sham "patriots only" elections on Dec. 19 that look like they'll be very poorly attended. There's no point in voting because all opposition and pro-democracy candidates have pulled out or are barred from running.