China Evergrande Group (EGRNY and HK:3333) continues to drive the market discussion on a holiday-disrupted week here in East Asia, though here on Wednesday there has been some respite.
Evergrande's main mainland operating business, Hengda Real Estate, said in a statement that it would make the US$35.6 million coupon payment on its Shenzhen-traded September 2025 bond when it comes due on Thursday. Nevertheless, Fitch estimates it owes US$129 million in coupon payments on its offshore high-yield bonds due this month, and there has been no word on whether it will make those payments.
To ease concern about the broader financial system, the Chinese central bank poured C¥120 billion (US$18.6 billion) in liquidity into it on Wednesday through reverse repo repurchase agreements.
Trading in Evergrande's onshore bonds is halted, first at Hengda's request, and now takes place only through negotiated transactions. The company reportedly missed payments to two banks on Monday, and it owes an enormous US$300 billion in total, which would amount to 1.8% of China's entire economy.
I was discussing the situation with a hedge fund manager friend of mine. He says equity investors are likely to be wiped out and holders of the company's high-yield offshore bonds also likely need to have their heads examined. But, being a hedgie, he's also looking for opportunity.
The winners out of an Evergrande implosion are likely to be well-capitalized Chinese developers such as China Vanke (HK:2202 and (CHVKY) ) and China Resources Land (HK:1109 and CRBJY). State-backed CR Land, as the latter developer is known, has seen its shares slip only 6% this year. China Vanke was the largest developer in China before Evergrande wrested away that crown and it makes higher-end apartments. Its shares have slipped 26% this year.
Vanke and CR Land will be in the right position to take uncompleted or unsold property projects off Evergrande's hands at cents on the dollar. They have strong brands and will be the names homebuyers gravitate toward.
Evergrande's brand is shot, with its name splashed across the front pages and social media feeds filled with images of the chaotic protests by holders of apartment deposits and its wealth management products at its Shenzhen headquarters, just across the border from me here in Hong Kong. If it is going to survive in any shape or form, it will need to recapitalize by selling off assets at wholesale or discount prices.
A matter of faith
The unknown is how much the whole Evergrande episode has shaken faith in the property market as a whole. Chinese developers fund the construction of their projects by taking deposits on so-called "off-plan" apartments that have yet to be built. Confidence in that system is reeling right now.
Independent research house T.S. Lombard believes the reckoning will come next year and in the longer term rather than right now.
"The industry's dominant financing model is at risk of imploding as potential home buyers boycott the pre-sale deals that provide the bulk of the industry's working capital," Lombard says in a note to clients. "A slowdown in activity in the property sector next year appears unavoidable."
Chinese President Xi Jinping repeatedly has attacked what he calls the "disorderly expansion of capital," a phrase he first used last December in a Politburo meeting of the cabinet. That precise wording has now been picked up by multiple ministries as well as the state-owned press.
Xi himself has now used the phrase five times in the last 10 months. It's clear he is criticizing the capitalist model of the economy. China has become a capitalist economy that risked bucking off the Communist dictatorship perched atop. The rider wants to wrestle back control of the horse. Bloomberg counts another 38 references in the flagship People's Daily state newspaper. The securities regulator says combating the "disorderly expansion of capital" is one of its top policy goals. Though it is not clear exactly what that means, you can be sure that overleveraged property developers are currently top of mind.
Xi has been bringing the Chinese Communist Party's policies back to some of its Marxist-Leninist roots as the party prepares for its once-in-five-years party congress next year. He will be seeking an unprecedented third term and has eliminated any challengers to his role as "Emperor for Life." He first used the "disorderly expansion of capital" phrase soon after personally intervening to nix at the last minute the planned world-record initial public offering of Ant Group, the Alibaba Group Holding (BABA) fintech spinout.
At first, Xi's thinking seemed devoted to restraining China's Big Tech sector. But the Evergrande episode is surely encouraging him to expand his focus. Xi, at the same time as criticizing capital flows, has wiped out references to private capital and the private sector in his speeches. The central government has attacked an expanding roster of industries, says the time of getting rich quick is over, and at Xi's behest is looking at the issue of wealth redistribution.
Xi has no sympathy for billionaire tycoons such as Evergrande founder Hui Ka-yan. Forbes rated Hui the richest man not just in China but in all of Asia in 2017, but figures his wealth has fallen from a height of US$42.2 billion to US$10.7 billion now in its real-time ranking.
Beijing's bigwigs, often incredibly wealthy themselves behind the scenes, are perfectly happy to let people such as Hui suffer. But the thing the Communist Party, as an unelected autocracy, fears above all else is social instability. And nothing quite scares and angers people such as the prospect that they're about to lose their homes.
Evergrande's grand plans
Evergrande owes money on 1.4 million properties that it currently has under construction, leaving it with around C¥1.3 trillion (US$201 billion) in presale liabilities for properties it has committed to build, according to Capital Economics. To put that into perspective, there are currently 2.9 million properties in all of Hong Kong with its 7.4 million population.
To put that into a U.S. context, a major city about the size of Los Angeles (3.9 million people, 1.5 million homes) is currently being built by Evergrande alone, right now. That's a huge amount of social unrest if all those folks get out into the streets.
Midweek, we are seeing a reassessment of the broader risk of Evergrande exposure. Although the situation has been compared to China's "Lehman Brothers moment," it is unlike the Lehman bankruptcy in that Evergrande's woes have crept up gradually, don't extend throughout the financial system, and leave the developer with ready, real assets on hand: bricks and mortar and land to sell.
So we could see a rally today for Evergrande's over-the-counter U.S. listing EGRNY. It's down 31% so far this week, and there's an unusual arbitrage play because the company's main Hong Kong listing HK:3333 is not trading today due to a local market holiday.
Evergrande also has a euro-denominated listing that trades in Frankfurt. That stock, FRA:EV1, shot up nearly 40% today although it's now a penny stock after descending 74.5% so far this year, even after those gains.
Hong Kong and South Korean stocks are closed today for the day after the Mid-Autumn Festival. You're expected to stay up late to watch the moon with family on the day itself, which was a holiday in mainland China and Taiwan as well.
Evergrande's Hong Kong stock is down 84% in 2021 and sits at a decade-long low. Its U.S. denominated bonds are trading at highly distressed levels of 24.5 cents on the dollar. Funds managed by Ashmore (US$400 million), BlackRock (BLK) (almost US$400 million) and UBS (UBS) (US$300 million) are the largest holders of the high-yield debt, according to data compiled by Bloomberg. Chinese high-yield developer debt is a staple feature of emerging-market bond indexes and normally is a great way to goose returns.
Big payments due on the horizon
Fitch estimates Evergrande owes US$850 million in bond coupon payments by the end of the year, much of it held by international investors. Blackstone (BX) , Fidelity, Goldman Sachs (GS) and Pimco are also on that roster.
The company's separately listed subsidiaries have also been savaged, with its electric vehicle spinoff China Evergrande New Energy Vehicle (HK:0708) down 90.5% in 2021 and its property management unit Evergrande Property Services (HK:6666) down 51.5% in the same time frame.
The electric vehicle unit has not come up with any of its own intellectual property, instead buying battery technology from other operators. It may never make a sellable car. At least the property subsidiary manages up-and-running properties.
In Shanghai and Shenzhen, mainland stocks resumed trading today after a two-day long weekend. The CSI 300 index of the 300 largest companies fell 0.7%, a showing that indicates investors do not see systemic risk to the overall market, although Chinese stocks are bumping around near their lows for the year. The benchmark is down 8.5% so far in 2021.
The Topix fell 1.0% today in sympathy in Tokyo. Nomura notes a spillover effect from Evergrande's woes splashing onto Japanese housing and property stocks.
Could the Evergrande implosion cause problems throughout the property sector? Real estate is the largest single private industry in the Chinese economy, at 14%. The Rhodium Group consultancy estimates there's enough empty apartments in China to house 90 million people.
That has long prompted doomsayers to predict the explosion of a bubble in Chinese property. By measures such as income to property prices, homes in China are exceedingly expensive.
The median home costs 49.1 times annual income in Beijing, with Shenzhen (46.9 years of income) and Hong Kong (44.7) not far behind, according to the handy affordability tracker from Numbeo. That makes them Nos. 4, 5 and 6 in the most expensive cities in the world to buy a home. Above them are only oddities such as Damascus, Syria, Accra in Ghana and Tehran in Iran, where depressed incomes come into play.
Tricky juggling act
The Chinese Communist Party would simultaneously like to teach fat-cat property tycoons a lesson by letting a few developers go under while maintaining confidence in the housing system. It is a tricky act to pull off.
It started juggling those balls in August 2020, when Chinese regulators imposed a policy of the "three red lines" to restrict overleverage at property companies. Developers need to maintain a liability to asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash to short-term debt ratio of more than 1x. Only 6% of Chinese developers could satisfy all three red lines, S&P said at the time of their introduction.
It is now up to developers to keep those juggling balls in the air. But local Chinese governments make the lion's share of their revenue by selling land for housing. Chinese banks, many of them state-owned, have lent extensively to fund those purchases.
Anyone who makes any money in China has few places to put it. The stock market is highly erratic, many companies are of dubious quality, and the policy risk of sudden, overnight change is extreme. Homes are the No. 1 place you put your yuan.
But public faith in a property market is a fickle thing. At the very least, letting the hot air out of the property market will hamper China's home prices for the next few years. If the Beijing leadership overestimates its power over the property market, the price descent could get out of hand.