Hong Kong stocks are taking a hammering today as panic over a potential collapse of China's largest developer by sales, the China Evergrande Group (EGRNF) and (HK:3333), spooks investors into other junk-rated Chinese developers.
The market is looking askance at companies such as Guangzhou R&F (GZUHF) and (HK:2777) and the Fantasia Group (HK:1777), which have both suffered recent downgrades by ratings agencies.
The Hang Seng index fell 3.3% on Monday, taking it to the same level as last October. The Hong Kong benchmark is now down 12.3% for 2021.
Evergrande shares lurched another 11.4% downwards, leaving them with an 84.1% decline this year, and standing at an 11-year low. But there is a broad selloff among China-focused developers, with the Hang Seng Properties Index off 6.7% on Monday. That properties index is down 14.5% since the start of the month, and rests at a five-year low.
Chinese developers have found ready takers among international investors for their high-yield bonds. When times were good in China's property industry, sales and prices kept rising, and the cash kept flowing to support high debt levels at those homebuilders.
The situation changed in August 2020, when Chinese regulators imposed a policy of the "three red lines" to restrict overleverage at property companies. Developers have 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 6.3% of Chinese developers could satisfy all three red lines, S&P said at the time of their introduction. China Evergrande, Guangzhou R&F are still crossing all three and stand firmly in the red, as do a long list of smaller companies among the 99,544 property developers in China.
They risk spinning into a vicious cycle of negative news. Chinese homebuilders thrive by selling properties off-plan, meaning they take deposits to reserve units that are yet to be built. When a property company's name is in the news as "troubled" on the debt front, who in their right mind is going to put down 5% or 10% of the purchase price of an apartment when there's a strong suspicion that the company may collapse? This then robs the developers of their lifeblood, making it all the more difficult for them to complete construction and sell homes.
Already, a series of Chinese developers including China Fortune Land (SH:600340) and Oceanwide Holdings (HK:0715) have this year defaulted on overseas-held debt.
Every time that happens, you have sell-side analysts telling us that the issues are company-specific, with little spillover risk. But we can safely say there's a pattern. Since many Chinese companies mask their true financial situation, and often have hellishly complex structures of holding companies, project-specific subcompanies and cross-held subsidiaries, it's hard to tell who is really struggling until they stop making payments, or warn on profits.
The Chinese authorities have reportedly told borrowers that Evergrande will not be able to meet the obligations on its loan-interest payments due this week. Fitch estimates it owes US$129 million in coupon payments on its offshore high-yield bonds due in September, and US$850 million by the end of the year, much of it held by international investors such as BlackRock (BLK) , the Blackstone Group (BX) , Fidelity, Goldman Sachs (GS) and PIMCO.
Standard & Poor's warns that nonpayment risk is "extremely high" at Evergrande. A debt restructuring is likely, meaning a "default scenario is a virtual certainty," the ratings agency says.
And Chinese banks are preparing for just such a likelihood, according to Reuters. Agricultural Bank of China (ACGBF) and (HK:1288), one of China's "Big Four" state-owned banks, has made loan losses for part of its exposure to Evergrande, the news agency reports. China Minsheng Banking (CGMBF) and (HK:1988) and China CITIC Bank (CHCJY) and (HK:0998), also major lenders to the property company, are prepared to roll over some near-term debt obligations, according to the report.
Evergrande owes US$300 billion, which would amount to 1.8% of China's entire economy. That exposure is also broad-ranging. It owes money to 128 banks and 121 nonbanking financial companies, according to a leaked document last year.
Comparisons to the Lehman Brothers collapse may be a little over the top, as I explained on Wednesday. The unwinding of Lehman's derivatives left all financial institutions a little uncertain of their counterparty risk. That froze the financial system.
Evergrande's problems, though, risk scaring homebuyers away from a real-estate sector that is the largest private industry in the Chinese economy, at 14%. Chinese regulators have demonstrated that they are happy to let some homebuilders go under. I'd bet on a managed bailout of Evergrande, which might be taken into state control, split up and sold off.
Evergrande is battling to get its enormous debt load under control - and flailing around. Its efforts to sell off assets have so far failed. Those holdings including its Hong Kong local headquarters, its single-biggest asset and worth some US$2 billion, as well as its separately listed subsidiaries China Evergrande New Energy Vehicle (HK:0708), an electric-vehicle business that has yet to make or sell any cars, and Evergrande Property Services (HK:6666), which manages some of the properties it has built and sold off.
Evergrande Property shares are down 52.8% so far this year. That leaves them at HK$4.08, less than half their HK$8.80 listing price when the company spun out in December 2020.
China Evergrande New Energy Vehicle have fared even worse than their parent, down 90.5% in 2021. They had reached a record high in January when a group of influential investors bought into the stock. But with the company having only licensed new-battery technology, while creating no intellectual property of its own, it is not at all clear how the company will contend with competitors such as Xpeng Motors (XPEV) and (HK:9868), Nio (NIO) and Li Auto (LI) and (HK:2015). Those local rivals have successful models and are seeing sales ramp up as they bite into the Chinese market first claimed by Tesla (TSLA) .
The movie-streaming service HengTen Networks Group (HK:0136) is also struggling, down 20.8% this year. Evergrande owns the largest stake in the company, at 26.6%, though it has been selling that down to its partner Tencent Holdings (TCTZF) and (HK:0700), which owns 23.9%.
Trading is thin. Aside from Hong Kong, almost all of East Asia's markets are closed today. Shanghai and Shenzhen in mainland China as well as the Korea Exchange in Seoul and the Taiwan Stock Exchange are all closed for the Mid-Autumn Festival, a harvest festival that in terms of gathering with family for a meal is the Chinese equivalent of Thanksgiving. The Tokyo Stock Exchange is closed too, albeit for Old Age Day, one of those "only in Japan" elements of life in Asia...
Chinese Estates Holdings (CESTY) and (HK:0127) tycoon Joseph Lau, a key ally of Evergrande's founder, has been selling down his stake in the property developer. He and his wife have sold 138 million shares in Evergrande over the last month, raising around US$64 million, and slashing their holding in the company to 8.0%. They remain the second-largest shareholders behind founder Hui Ka-yan.
Besides banks, stock investors and bondholders, Evergrande also owes money to investors who bought its high-return "wealth-management funds." The business magazine Caixin reports those liabilities are around C¥40 billion (US$6.2 billion). Retail investors who have bought those products - their holdings are murky but they promise high guaranteed returns - are reportedly being offered three options: cash instalments over up to five years; discounts of 28% to 52% on Evergrande apartments, shops and car-park spaces; and to own a share of the payables that apartment buyers have already put down on their properties.
It will take extensive negotiations with lenders for Evergrande to survive this onslaught. Its own sales will have dried up amid the debt scare. These are the hard yards put in by M&A specialists Houlihan Lokey and the debt capital-markets specialists Admiralty Harbour Capital if they are to craft a turnaround that will see the company survive. The calculators are out to see how many cents on the dollar remain.
