THE US FEDERAL RESERVE’S latest semi-annual financial stability report comes with an uncommon warning about China’s financial stresses, not the sort of thing it typically comments on.
Its concern is that the stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States:
In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched. In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group. Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.
Was it just two months ago that Fed Chair Jerome Powell said that the risks from Evergrande’s troubles seemed very particular to China?
BELEAGUERED PROPERTY DEVELOPER Evergrande dodged its October 23 debt default deadline, making an $83.5 million payment to its international bondholders due on September 23, just before the 30-day grace period expired.
That was the first of five coupon payments it has missed on their due dates, totalling a combined $275 million.
It is unclear where Evergrande got the $83.5 million from, but it has bought another week of breathing room, although the company will still be breathing hard under the weight of its more than $300 billion in liabilities.
One place the funds for the coupon payment did not come from was the hoped-for sale of control of its core property business, Evergrande Property Services. Talks to sell a 51% stake of Evergrande Property Services to Hong Kong-listed Chinese property developer Hopson Development fell through.
Trading of shares in Evergrande Property Services resumed on Thursday on the Hong Kong stock exchange, having been suspended since October 4 pending a possible general offer for its shares. Evergrande said the day before that there had been no material progress in asset sales. The last significant disposal was a 20% stake in Shengjing Bank to an agency of Shenyang city’s government.
However, the company has restarted work on up to 10 projects in six cities, including Shenzhen. On August 31, it had acknowledged that delays in paying suppliers and contractors had forced the suspension of some projects. However, its statement on Sunday on WeChat announcing the resumptions did not disclose on how many of its 1,300 developments across China it had halted work.
Last week, People’s Bank of China Deputy Governor Pan Gongsheng reiterated that the risks from Evergrande are controllable, property sector financing is returning to normal, and that the bank will protect households and suppliers.
Not many investors in financial markets share the central bank’s sanguinity. First, there is the ever-present risk of default. Each grace period is starting to feel like a round of Squid Game for Evergrande.
Second, the speed and depth of the slowdown of China’s property market that the crisis has triggered are raising concerns about the extent to which they will weigh on GDP and whether authorities can balance reducing the cost of living by making housing more affordable with managing decelerating growth.
A THIRD WEEK; a third round of missed bond payments by beleaguered property group Evergrande.
Reports say the group missed coupon payments totalling $148 million due today. That follows two sets of payments missed in September. The clock is ticking down on the 30-day grace period on the first of them before a default must be declared.
The developer has more than $300 billion in liabilities.
The fear is of the debt crisis spreading to other developers. A total of $92.3 billion of bonds issued by Chinese developers fall due over the next twelve months. Developers with weak credit ratings are already finding refinancing their debt next to impossible.
Fantasia Holdings, a mid-sized developer based in Shenzhen, has already defaulted on $206 million in payments due. Sinic Holdings, which develops residential and commercial property across China, told the Hong Kong Stock Exchange on October 11 that it would likely default on a bond payment due on the 18th of this month. Beijing-based Modern Land is asking its bondholders to extend payment-due deadlines by three months.
If the sector’s liquidity problems do not improve, further defaults seem inevitable. The question would then become how much contagion there would be in the rest of the economy, of which real estate accounts for a quarter.
Managing a soft landing for the sector’s most troubled companies without making an overt bailout remains a high priority for authorities. More measures at the municipal and provincial level to support developers, such as Harbin’s release of presale funds held in government escrow accounts to ease cash flows, are likely.
THE DOMINOES in China’s property market are teetering, even if the first has yet to fall.
Fantasia Holdings, a mid-sized developer based in Shenzhen that the rating agency S&P downgraded to triple C last week, suspended trading in its shares on the Hong Kong exchange on Tuesday after announcing that it had defaulted on a $206 million bond the day before.
It has a further $1.9 billion of offshore bond payments a d $992 million of onshore bond payments due by year’s end. Last month, the company had told investors that it did not have a liquidity issue.
Stress is clearing rising in China’s property sector and the high-yield bonds that underpin it. Fantasia joins beleaguered Evergrande in suspending its shares. In addition, rating agency Fitch has cut its grading of another developer, Shanghai-based Sinic Holdings, to C from triple C. There is only one further cut left, to D for default.
Evergrande, which is selling assets where it can to prevent being dragged under by total liabilities of more than $300 billion, is expected to announce that it has sold 51% of its property service business, which is listed in Hong Kong, to Hopson Development for $5 billion. Evergrande missed an interest payment on an offshore bond on September 23, triggering a 30-day grace period before a formal default.
Evergrande has said nothing formally beyond an exchange filing that it was suspending trading in advance of a ‘possible general offer’ for its Hong Kong-listed shares. Any such offer could be imminent or could not come for some time, with Evergrande’s shares, which had fallen 80% this year, remaining suspended in the interim.
Beijing has also been officially silent on the sector’s problems, even if authorities are orchestrating as soft a landing as they can behind the scenes. Spoiler alert: it will still be pretty bumpy, especially for bondholders.
EVERGRANDE’S SALE OF a 20% stake in Shengjing Bank to an agency of Shenyang city’s government provides a snapshot of how the beleaguered property group is being bailed out.
Shenyang Shengjing Finance Investment Group will pay 10 billion yuan ($1.55 billion) for the stake, but the proceeds will be used to offset Evergrande’s liabilities to the bank. Evergrande retains a 14.6% stake in the bank.
Cash-strapped Evergrande has already shed various assets, including 25 billion yuan worth of property and an earlier 2% stake in Shengjing Bank that raised 1 billion yuan.
More such asset sales are likely, as authorities actively nudge the restructuring of the group’s debt. They have moved to limit contagion from Evergrande spreading after the company missed several interest payments this month to lenders, contractors and suppliers, as well as an $83.5 million coupon payment due on a dollar-denominated offshore bond and concocted a palliative deal with its onshore bondholders.
More deadlines are approaching on its local and offshore bond obligations, including a $45 million bond payment due today, on which Evergrande is likely to invoke its 30-day grace period to make payment. The rating agency Fitch cuts its rating for Evergrande to a ‘C’ today, which signifies a company in ‘near default’. It is Fitch’s fourth downgrade of the group since June 22.
Evergrande has outstanding international debts of about $20 billion and total debt of around $300 billion. More than 100 Chinese banks have lent money to Evergrande, and 1.4 million new housing units have been sold but not completed.
The restructuring will prioritise homebuyers, then contractors and suppliers owed money, followed by domestic investors in Evergrande’s financial products. Foreign investors will be at the back of the queue.
FOR A COMPANY whose $300 billion of debt sent shivers through investors around the world, sketchy news that it has resolved a $36 million interest payment that was due on Monday seems more a palliative than the curative medicine investors are taking it to be.
Even though it is the equivalent of a doctor telling a patient to take two aspirins for a broken leg and see how they feel in the morning, the announcement by Hengda Real Estate, the main property unit of the world’s most indebted if no long largest real estate developer, Evergrande, that it reached an unspecified agreement with holders of one of its onshore bonds appears to have eased the pain in the financial markets.
International investors have now returned to worrying about something they at least think they understand how to worry about, inflation and stimulus unwinding. Evergrande’s financial accounting is more opaque than even central bank monetary policy.
However, the announcement said nothing about the little matter of an offshore bond on which an $84 million coupon payment falls due on Thursday, although it has a 30-day grace period.
On Monday, Evergrande reportedly missed interest payments to at least two of its biggest lenders. Authorities remain concerned about the systemic financial risk that Evergrande’s sprawling debt obligations pose if there is a disorderly collapse of the group.
They also worry about the potential spillover into the real economy, which risks social instability and thus is a political matter. The group owes $147 billion to unsecured trade creditors such as suppliers, while some 1.5 million disgruntled buyers of Evergrande homes off plan who now face losing their deposits will, at the very least, vent to let off steam, even if more serious protest will be contained.
One reason that the amount owed to trade creditors is so eye-popping is that Evergrande systematically deferred payments to its suppliers so it could cut its interest-bearing liabilities, which it succeeded in doing, reducing them by some 145 billion yuan ($22.4 billion) to 571.7 billion yuan as of end-2020..
For now, the ‘d’ word has been avoided — and authorities have the administrative tools to ensure it stays that way. That will dull the pain and provide temporary relief, if not a cure.
Update: Regulators have reportedly instructed Evergrande to focus on completing unfinished properties or repaying deposits while avoiding a near-term default on its dollar-denominated bonds. Beijing is also said to have told local officials and state-owned enterprises to step in with bail-outs only as a last resort in the even of a disorderly collapse of the property developer.
AUTHORITIES BEGAN TO tighten their regulation of China’s property sector last year, fearing real estate developers’ debt was the country’s most significant systemic financial risk.
A slowing economy has only further exposed the property bubble and the extent of its over-leverage. The sector now faces a crisis that is coming to a head with the fate of one of its largest property developers, Evergrande, which has been offloading its properties at firesale prices to meet the new regulatory requirements.
According to the National Bureau of Statistics, home sales (by value) fell 20% year-on-year in August, while new homes prices rose at the slowest rate this year.
Evergrande, which faces defaults on some of its $300 billion of debt owed to its bankers this week, is widely considered on the verge of bankruptcy. Its scramble to sell assets fast enough to raise the cash to avoid defaults only pitches the property market into a vicious cycle of falling prices that risks bring down even more developers.
Evergrande’s share price has fallen by approaching 90% in the past six months, and global credit rating agencies have downgraded the firm’s bonds deep into junk territory. Yet Evergrande is ‘too big to fail’ both economically and politically.
A bailout of some kind is all but inevitable. The open questions are how it will be dressed up to reduce moral hazard and assuage widespread outrage — beyond the collapse in home values, more than a million people face losing deposits on unfinished homes — and who will foot the bill?
Secured creditors like bondholders account for one-third of Evergrande’s liabilities. Of the remainder, It owes about $147 billion in trade and other payables to suppliers. The risk of the impact rippling through the real economy is significant. Authorities may still be grabbling with quite how extensive and risky those supply chain linkages are.
A way will be found to move Evergrande’s bad debt into official hands, albeit, to mix metaphors, through gritted teeth. The scale of the required rescue is greater than anything experienced with Anbang and other over-extended corporate casualties. The political will also feels weaker, though it will be stiffened as needs be.
Authorities will also have to adjust the expectations of those who invest their savings in a home in the belief that property values never go down.
This all has some of the feeling to it of both the collapse of Japan’s property bubble in the 1980s and the Lehman Brothers bankruptcy in the United States in 2008. Evergrande is systemically important, and its failure would reverberate across the economy with unintended consequences, perhaps for years.
The policy decision to be made is a very high-stakes one. Beyond avoiding a corporate credit crunch, there is the question of whether the potential impact on local authorities is fully understood. Is there reliable data on which to make that assessment?
This Bystander expects a cautious forced restructuring with the bad debt being buried, not resolved. Some executives will undoubtedly be labelled corrupt, official fingers of blame will be pointed at ‘speculators’ and punishments, arbitrary or otherwise, doled out.
Other official fingers will be tightly crossed, hoping to get through the crisis without triggering the economic conditions that befell Japan in the 1990s or the political tensions in the United States that have followed the 2008 global financial crisis.