This briefing and podcast was originally published as the Daily Contrarian episode on Sept. 16, 2021. It has been slightly reformatted since, but should still provide an idea of what these daily episodes are like. Sign up for the free trial by clicking on the link below.
The attention is squarely on China and that is where we will focus this issue. Earlier today, Evergrande (OTC:EGRNY) suspended trading in onshore bonds following a downgrade. Trouble has been brewing for China’s largest real estate developer for some time. It goes back to various new limits and rules imposed by Chinese authorities on the country’s developers in recent years. This as part of a push to cut financial risks and promote affordable housing (and clean up corruption, as real estate is one of the easiest ways to launder money. You can even wash your yuan for USD-denominated HKD’s in Hong Kong’s property market).
Now the company, with more than $300 billion-worth of debt, is scrambling to raise funds and keep up with interest payments. Already, government authorities have told the country’s banks not to expect payment on the next round due next week.
(Source of image: Evergrande.com)
This is leading to an intensifying sell-off in Chinese property stocks. One can expect financials to not be far behind. The question is how far the whole thing reaches and what else will be caught up with the collapsing dominoes. An Evergrande default is viewed as “some kind of probable” by Fitch Ratings.
The ratings agency for its part says the risk of significant pressure on home prices in the event of a default would be low, “unless the restructuring or liquidation of [Evergrande’s] assets becomes disorderly. Fitch believes this is something the authorities will want to avoid.”
Right, but this would not mean a bailout in the U.S. sense. More likely the government would take over Evergrande and replace (and/or imprison or otherwise disappear) existing management. Creditors would still be on the hook. And what about retail investors who fronted Evergrande their savings for development projects that have yet to be built? That’s the bigger concern. There have been increasing protests in Shenzhen outside the company’s headquarters, in Jiangsu and elsewhere.
The bloom is well and truly off the rose for China. CCP authorities may be able to step in and offer some semblance of control and ride out this particular crisis. But the problems are too pervasive for western investors to ignore. The whole thing probably isn’t a Lehman moment as China (to my knowledge at least) doesn’t have a mortgage securitization market, or certainly not one tied up with credit default swaps held by the world’s financial institutions. But it would be quite interesting to see who in the U.S. has exposure to China’s banking and real estate sectors. Probably this is a bigger group than might be expected and likely includes private equity.
If that is all forced to unwind it could bring second- and third-order effects nobody is quite aware of yet. And even if it is all contained to China but the country’s economy melts down, it will be trouble for all the western exporters that have staked their growth prospects on selling to China’s growing middle class.
So yeah, this whole thing bears watching.
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