Evergrande Moment 

Doug Nolan


Evergrande owes over $300 billion – to banks and non-bank financial institutions, domestic and international bond holders, suppliers and apartment buyers. 

It has bank borrowings of $90 billion, including to Agricultural Bank of China, China Minsheng Banking Corp and China CITIC Bank Corp. (reports have 128 banks with exposure). 

Thousands of suppliers are on the hook for $100 billion. 

It appears an Evergrande debt restructuring is inevitable. 

From a few decades of close observation, these types of situations generally prove worse than even the more bearish analysts fear. 

Assume ugly and messy. 

The presumption all along – by bankers, investors and apartment purchasers – was that Beijing would never allow a collapse of such a huge player. 

This fundamental market perception is in serious jeopardy.

Evergrande is the most indebted of a highly levered Chinese developer sector (top three in revenues). 

It “owns more than 1,300 projects in more than 280 cities.” 

Evergrande employs 200,000 – and “indirectly helps sustain more than 3.8 million jobs each year.”

From CNN (Michelle Toh): 

“Outside housing, the group has invested in electric vehicles, sports and theme parks. 

It even owns a food and beverage business, selling bottled water, groceries, dairy products and other goods across China. 

In 2010, the company bought a soccer team, which is now known as Guangzhou Evergrande. 

That team has since built what is believed to be the world's biggest soccer school, at a cost of $185 million to Evergrande. 

Guangzhou Evergrande continues to reach for new records: It's currently working on creating the world's biggest soccer stadium, assuming that construction is completed next year as expected. 

The $1.7 billion site is shaped as a giant lotus flower, and will eventually be able to seat 100,000 spectators.”

Evergrande epitomizes China’s historic Credit Bubble. 

It has borrowed and spent lavishly, in what history will surely view as a company that operated at the epicenter of an extraordinary Bubble of asset inflation, speculation and reckless debt-financed mal-investment.

Estimates have Evergrande bond holders receiving 25 cents on the dollar in a restructuring. 

It borrowed $20 billion in the booming off-shore dollar bond marketplace. 

As a focal point of the global Bubble in leveraged speculation, China’s offshore debt market has ballooned during this protracted cycle. 

From the FT (Hudson Lockett and Thomas Hale): 

“Chinese issuers face their largest-ever wave of dollar bond maturities this year at $118bn, according to Refinitiv. 

But even that is dwarfed by the Rmb7.8tn ($1.2tn) of onshore debt maturing in 2021. 

The latter figure could have big repercussions for offshore bondholders, especially if the restructuring of onshore debt is prioritised.”

“Money” has flooded into China this year, in yet another example of the incredible “Terminal Phase” dynamic, where speculative finance inundates a system even in the face of acute Bubble fragility. 

Unwieldy speculative flows only exacerbate systemic vulnerabilities. 

Trouble for Evergrande, the developers and Chinese high-yield debt marks a momentous inflection point for Chinese and global leveraged speculation. 

From CNN (Michelle Toh): 

“Goldman Sachs analysts say the company’s structure has also made it ‘difficult to ascertain a more precise picture of [its] recovery.’ 

In a note this week, they pointed to ‘the complexity of Evergrande Group, and the lack of sufficient information on the company’s assets and liabilities.’”

When a Bubble is inflating - asset prices rising and finance flowing freely - the “complexity” of corporate structure and lack of transparency matter little. 

Then suddenly, when speculative financial flows reverse, Bubbles falter and finance tightens, attention shifts to risks embedded within tangled financial arrangements. 

Why worry about Chinese debt if Beijing is there to underpin the marketplace (not to speak of the entire financial system and economy)? 

Besides, one can always hedge risks as necessary. 

Quite simply, the risk vs. reward calculus for speculating in high-yield Chinese debt could not have appeared more attractive (especially in a yield-starved world!). 

But these bullish perceptions are now being blow apart. 

Understandably, Beijing is reluctant to become entangled in this financial quagmire. 

And who today is willing to write default protection on Evergrande-related obligations? 

Who’s would want to sell flood insurance with torrents of rain coming down?

Bloomberg (Laura Benitez): 

“Evergrande Bondholders Find No Takers in Efforts to Hedge Risk: ‘Absolutely no bank is willing to provide a hedge, at least not in size,’ Jochen Felsenheimer, a managing director at XAIA Investment in Munich who trades CDS and bonds, said… Both speculators and bondholders are failing to find counterparties to hedge their liabilities, he added.”

Developments point to a momentous shift in speculative dynamics. 

Bond prices are collapsing in increasingly illiquid markets. 

Evergrande bonds faced trading halts during the week. 

Hedges for a company with hundreds of billions of liabilities are no longer available. 

Such circumstances dictate that speculative leverage must be reduced, with losses and illiquidity impacting the risk vs. reward calculus for other sectors and markets – in China, Asia and globally. 

Contagion gathered important momentum this week.

September 16 – Bloomberg (Sofia Horta e Costa): 

“Intensifying concern over the impact of a China Evergrande Group default is rippling through the nation’s financial markets. 

Developers led declines on the Hang Seng China Enterprises Index, with Country Garden Holdings Co. -- the nation’s largest developer by sales -- losing 7.2% and Sunac China Holdings Ltd. sinking 11%. 

This week alone the two stocks have fallen more than 21%. 

China’s high-yield dollar bonds fell as much as 4 cents on the dollar Thursday…, with those issued by Fantasia Holdings Group Co. -- a weaker-rated developer -- down about 10 cents. 

Yields on China’s junk notes have climbed to an 18-month high…”

According to Bloomberg (Shuli Ren): 

“Its inventory quality is really poor. 

To redeem its investors, apartments were offered at 28% discount to their market value, and parking lots were given away at a 52% discount… 

That’s because most of Evergrande’s projects are not prime real estate. 

As of 2020, 57% and 31% of its land acquisitions were in Tier-3 and weak Tier-2 cities… 

As of June, it was already taking the developer over 3.5 years to sell unfinished projects.”

“On top of this, Evergrande has sold wealth management products to its employees, suppliers and apartment buyers over the years. 

We don’t know how much is at stake — it was essentially off-balance-sheet shadow banking, which means its actual debt could be much greater. About 70,000 retail investors were tied up in these products, according to a REDD report.” 

Beyond the stated $305 billion of balance sheet liabilities, there is likely a major issue with “off-balance-sheet shadow banking.” 

Bloomberg, May 20th: 

“The [off-balance sheet] funding is often masked as equity offerings that are debt-like in nature. 

Another avenue is to provide guarantees to joint ventures or associates that borrow on behalf of the developers, Cheng said. 

Funding sourced via such guarantees for joint ventures accounted for about 9% of total debt issued by Fitch-rated developers last year, based on Fitch estimates, reaching a record 460 billion yuan ($71 billion). 

It’s outside of mainland China where the impact on developers has been most telling. 

One of the popular approaches in the past three years has been using so-called orphan special purpose vehicle structures to issue private debt, said Chen Yi, head of global capital markets at Haitong International Securities Group Ltd. 

Under such a structure, the issuer of the debt is an orphan that is not an affiliate or subsidiary of a company, so the debt won’t appear on the companies’ balance sheet… 

Companies that rely on joint ventures for financing could see such off-balance sheet debt accounting for as much as 40% of their debt, said Cheng.”

September 13 – Reuters (Clare Jim and Samuel Shen): 

“Cash-strapped property group China Evergrande Group said… it has engaged advisers to examine its financial options and warned of default risks amid plunging property sales… 

The real estate giant has been scrambling to raise funds it needs to pay lenders and suppliers, with regulators and financial markets worried that any crisis could ripple through China’s banking system and potentially trigger wider social unrest… 

Evergrande said two of its subsidiaries had failed to uphold guarantee obligations for 934 million yuan ($145 million) worth of wealth management products issued by third parties. 

That could ‘lead to cross-default’, which would ‘would have a material adverse effect on the group's business, prospects, financial condition and results of operations,’ it said…”

Evergrande issues go much beyond the bond market and financial engineering – to literally millions of individuals and businesses. 

Its employees, customers, and suppliers are heavily exposed.

September 14 – Bloomberg: 

“China Evergrande Group’s high-yield consumer products have become a lightning rod for the embattled developer, with investors protesting losses and delayed payments from accounts marketed as safe. 

More than 70,000 people across China have bought the wealth management products, Du Liang, general manager of Evergrande’s wealth division, said… About 40 billion yuan ($6.2bn) of them are now due, Caixin reported, citing people briefed by Du. 

Such off-balance sheet investment offerings are a key source of funding for cash-strapped Evergrande. 

The demonstrations that are breaking out across China could sway any bailout decisions by the government, which places a high priority on social stability.”

From Reuters: 

“Many of the [wealth management] investors are Evergrande workers, after the company encouraged staff to purchase the products. 

In Anhui province alone, 70% to 80% of local employees bought them and that’s likely to be the situation for branches nationwide…”

Reuters: 

“Hundreds of thousands of uncompleted units… need to be delivered to buyers.” 

“I collapsed when I heard that construction had halted. 

How my heart hurts,’ a middle-aged woman… told Reuters outside the sales office. 

“For regular folks like us, all our life-savings had gone into the house.”

September 16 – Reuters (David Kirton): 

“Wu Lei says his small construction company in central China has accepted commercial paper from property developer Evergrande as payment for two years but with that paper’s value now in doubt, his firm is on the verge of collapse. 

China Evergrande Group, saddled with more than $300 billion in total liabilities equivalent to 2% of China’s GDP, is in the throes of a liquidity crisis that has it scrambling to raise funds to pay its many lenders and suppliers… ‘We were working for Evergrande, so our suppliers trusted us with the materials without us paying upfront. 

Now they’re suing me, courts have frozen my property and I’ve sold my car. 

And I still have employees who need to be paid,’ he said. 

The plight of Wu and many others like him has thrown a spotlight on the extensive use of commercial paper in China’s property sector. 

Developers favour it as they prefer to not pay upfront and because it doesn’t count as interest-bearing debt.”

It's being dubbed “China’s Lehman Brothers Moment.” 

While a pivotal development for China’s vulnerable Bubble, it still seems premature to invoke the “Lehman Moment” comparison. 

The Lehman blowup was the culmination of 15-months of unfolding Crisis Dynamics. 

The crisis of confidence in Lehman’s “repo” market liabilities was the catalyst for panic liquidation and dislocation throughout the repo marketplace. 

In the “Periphery vs. Core” analytical framework, the U.S. repo market was at the system’s very core – perceived safe and liquid “money” suddenly viewed as involving significant risk. 

With the “repo” market providing a core funding source for the securities and derivatives markets, illiquidity and dislocation proved cataclysmic. 

The resulting panic unleashed de-risking/deleveraging dynamics that risked a systemic meltdown/financial collapse. 

Market perceptions abruptly shifted from “Washington will never allow a housing bust” to fears that crisis dynamics were spiraling out of the Fed’s control. 

At this point, the Evergrande crisis remains at China’s “Periphery.”

While they could allow defaults and a painful restructuring, markets remain confident that Beijing will safeguard China’s $55 TN banking system. 

Beijing is still perceived to be very much in control. 

And this explains why China’s top-tier onshore bond market has not been rattled. 

It also explains why the unfolding Evergrande collapse has yet to reverberate to U.S. and European Credit markets. 

Bloomberg: 

“Real estate contributes to about 29% of China’s economic output if its wider influences are factored in, according to a joint research by Harvard University and Tsinghua University.”

While not yet a “Lehman Moment,” a strong analytical case can be made that Evergrande presents a major catalyst for a deflating China Bubble. 

Bond investors will now approach housing finance with a much keener focus on risk. 

Apartment buyers will be less willing to provide developers big purchase deposits. 

Evergrande and others will unload apartments, with downside pressure on housing prices. 

Declining prices would likely see large quantities of unoccupied units (purchased for speculation) come to market, further depressing prices. 

Estimates have between 50 and 65 million empty Chinese apartments. 

Sinking prices would spur bankers to tighten lending conditions. 

Apartment bust.

September 14 – Bloomberg: “China’s residential property slowdown deepened last month, signaling that regulatory tightening and an escalating crisis at the country’s most indebted developer are hurting buyer sentiment. 

Home sales by value slumped 20% in August from a year earlier, the biggest drop since the onset of the coronavirus shut swathes of the economy at the start of last year, according to Bloomberg calculations based on National Bureau of Statistics data…”

Back during the U.S. mortgage financial Bubble period, the CBB would highlight a metric “Calculated Transaction Value” (CTV) – multiplying home sales by average selling prices. 

This was reflective of mortgage Credit creation, finance fueling housing inflation, and new purchasing power propelling the Bubble Economy. 

And when a tightening of mortgage Credit led to slowing transaction volumes and falling prices, CTV indicated the degree of Credit slowdown weighing on the economic boom. 

There is now ample evidence of a marked Chinese Credit slowdown. 

It may not be a “Lehman Moment,” but it’s definitely an “Evergrande Moment.” 

And it’s difficult to envisage sufficient Credit growth to sustain China’s historic Credit and apartment Bubbles.

“The U.S. will not allow Mexico to collapse” – 1994. 

“The West will never allow Russia to collapse” – 1998. 

“Washington would never tolerate a housing bust” – 2007. 

“Beijing has everything under control and will do whatever it takes to sustain China’s boom” – 2021.

Late Bubble cycle exultant confidence in policymakers is the kiss of death. 

After all, faith that crisis dynamics will be summarily quashed by omnipotent central bankers and government officials ensures aggressive risk-taking, speculation and leveraging. 

I’ve studied these dynamics for a while now, but I’ve never witnessed such faith in the competence and power of a government as is these days afforded to the great Beijing meritocracy – and that’s here in the U.S. as much as in China.

September 14 – Financial Times (Sun Yu and Tom Mitchell): 

“China’s biggest cities have suspended land auctions after new central government rules failed to rein in prices, in a setback for President Xi Jinping’s campaign to reduce social inequality. 

The rules were introduced as part of Xi’s efforts to promote ‘common prosperity’ by cracking down on the high property costs borne by middle-class families, and were intended to reduce demand and runaway house prices. 

But they had the opposite effect, serving to drive up red-hot real estate costs.”

China has over 160 cities with populations of at least one million. As they say, “real estate markets are local.” 

And as I’ve been saying, China – their policymakers, bankers, apartment owners/speculators, regulators… – have no experience with the downside of Bubbles – no background in controlling housing manias. 

Evergrande is in serious trouble, and this places China’s Bubbles in jeopardy. 

Copper sank 4.6% this week. 

Iron Ore collapsed 16.0%, with Nickel down 5% and Lead 6%. 

Global resource stocks were under significant selling pressure. 

The commodity currencies were sold. 

It appears markets began discounting a Chinese housing downturn, with negative economic ramifications for China and the world. 

Silver fell 5.7%, Platinum 1.9%, and Gold 1.9%. 

As for precious metals weakness, perhaps traders are moving to get ahead of further dollar strength, a rally that would gain momentum in the event of abrupt renminbi weakness. 

Global markets showed signs of nascent speculator de-risking/deleveraging, with Chinese contagion stealthily gaining momentum. 

China, after all, evolved during this cycle into the marginal source of global Credit and, I believe, speculative leverage. 

The unfolding “Evergrande Moment” portends trouble ahead for myriad global asset and speculative Bubbles. 

However, complacency continues to reign throughout U.S. markets. 

Evergrande ramifications are dismissed, while attention remains fixated on a Fed seemingly determined to ride its reckless experiment in monetary inflation for as long as it can. 

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