Evergrande. Remember the name. The Chinese megadeveloper is rapidly morphing into some kind of Chinese ‘Lehman Brothers moment’.
The Three Red Lines policy that is designed to deleverage large developers has triggered this latest round of crisis. Evergrande is preposterously leveraged with its equity worth less than 10% of enterprise value, owing to huge debts that it is desperately trying to rationalise via asset sales, refinancing and discounted apartment sales.
The problem is, increasingly, all of Evergrande’s funding markets are drying up as they lose faith the developer’s ability to pull it off. So far we have seen:
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- Various banks pull funding lines.
- Local governments block apartment sales owing to illegally depleted escrow accounts for buyers.
- Contagion roar through its debt instruments.
- And crashing equity.
Evergrande’s 2025 bond is now priced at half face value and it has lost a quarter of equity in the past two days alone.
The latest penny to drop was this:
Long-simmering doubts about Evergrande’s financial health intensified this week after the developer had a $20 million bank deposit frozen by a local court and was hit with a sales ban by a city government alleging it failed to set aside enough funds in escrow accounts. The city later removed the ban, providing some relief for Evergrande’s stock, but investors remain worried the company isn’t selling properties and other assets fast enough to repay its $301 billion mountain of liabilities.
The sales ban has now been lifted after Evergrande replenished the siphoned funds but every local government in China is now checking those accounts. To wit:
If other cities in the mainland emulate Shaoyang, Evergrande will have to finish its projects quickly, and deliver the keys to consumers before getting paid. This, in turn, means Evergrande will have to work harder obtaining construction loans from banks, as well as smoothing out increasingly tense relationships with its suppliers. Both will be tricky. A few skittish banks have already decided not to renew their loans to Evergrande. The developer has missed a few payments on its commercial bills, a form of short-term payables to suppliers.
Contagion is sweeping into new markets:
Banks in Hong Kong including HSBC Holdings, its unit Hang Seng Bank and Bank of East Asia have stopped approving some mortgages for properties being developed by embattled China Evergrande Group in the city, four people familiar with the decisions say.
Friendships are being strained:
In the past, China Evergrande Group has always been able to wiggle out of trouble. In turbulent times, billionaire founder Hui Ka Yan would turn to his tycoon friends to prop up his stocks and bonds. The persistent support they’ve provided — buying up Evergrande debt — is why the developer is also Asia’s largest dollar junk bond issuer.
Hui’s pals were at it again earlier this week. As the real estate developer’s bonds tumbled to record lows, CST Group Ltd. said in a filing that it had bought $11 million worth of Evergrande bonds on the open market. Billionaire Cheung Chung Kiu — one of Hui’s buddies in what’s called the Big Two poker club — has a stake in CST. Last September, during another credit crunch, the investment firm bought Evergrande bonds as well, helping to stabilize a market that had grown jittery over another bad turn in the property developer’s fortunes.
Friends may not be enough now. This credit crunch is a lot more severe…The September scare was triggered by a purported letter to the government that pleaded for permission for a backdoor listing in Shenzhen to avoid a cash crunch. Evergrande said the letter was fabricated and was able to regain its footing after Hui convinced his pre-IPO investors — his long-time pals and suppliers — to take as equity about two-thirds of 130 billion yuan in hybrid securities due in January 2021.
This time, however, the credit scare is convincing banks and local governments to withdraw their support. How will Hui defuse this bomb? His poker club friends are, at best, stabilizing agents in Hong Kong’s capital markets. They can’t help with his business operations in the mainland.
With bankers and suppliers getting skittish, Hui will have to network among a much broader circle, perhaps proposing partnerships with fellow developers or even with state-owned enterprises — not the most selfless of allies. Whether or not he gets out of this bind will depend on Hui’s reputation. He’ll need more than friends.
Some say Evergrande is not too big to fail:
In my view, Evergrande is too-big-to-fail. Although $300bn isn’t the end of the world, the counterparty failure that can unleash in the Chinese development sector is. If Everegrande freezes then funding for all developers will freeze and the economic shock will be material. Chinese junk debt spreads are already blowing out:
At the end of the day, the issue is now one of political economy, via WSJ:
Ultimately, Evergrande’s fate rests with Beijing. The government’s drive to curb property sector debt has weakened funding for developers, sparking Evergrande’s current crisis. Given the importance of housing to China’s overall economy, tightening and easing policies usually come in cycles. But reining in the relentless debt-fueled expansion of companies like Evergrande, which pose an increasing systemic risk, seems likely to remain a top policy priority.
The government will try to contain any ripple effects to the financial system or home buyers but not all investors will be spared pain.
That seems about right to me. Some kind of Chapter11 process seems the most likely outcome. Which would still be highly disruptive to the development sector.
To put it bluntly, a classic Minsky moment is developing at the epicenter of global iron ore demand.