Evergrande’s fight for survival a threat to China’s shadow banking system
China Evergrande appears poised to rake in a large lump of cash. Where that cash might end up is, however, anyone’s guess.
On Monday shares in the reeling property giant’s $US7 billion ($9.6 billion) listed subsidiary, Evergrande Property Services group, were suspended in Hong Kong upending a “possible general offer for the shares in the company.”
Evergrande’s bond holders are going to see much, if any, of the cash the group is raising from sales forced by its liquidity and (more likely) solvency crisis.Credit:Bloomberg
Chinese media immediately linked the announcement to the simultaneous suspension of shares in another Hong Kong-listed developer, Hopson Development, “pending the release of announcement in relation to a major transaction of the company.
The media reports speculated that Hopson plans to buy a 51 per cent stake in the property services unit in a deal that values it at about $US5.1 billion, implying a major haircut for Evergrande.
A sale of its stake in Evergrande Services would follow the sale last week of Evergrande’s 20 per cent stake in Shengjing Bank to the local Shenyang government for $US1.5 billion. With the prospective sale of at least the bulk of its 61 per cent shareholding in its services business, it will therefore have raised more than $US4 billion.
It is unlikely, however, that Evergrande’s bond holders are going to see much, if any, of the cash the group is raising from sales forced by its liquidity and (more likely) solvency crisis.
The proceeds from the sale of its Shengjing Bank shares are already being claimed by the bank itself in repayment of loans it made to the distressed developer.
China’s authorities have also made it clear that their priorities are ensuring Evergrande’s woes don’t precipitate a banking crisis, that pre-sold apartments are completed and that retail investors are repaid.
The fate of investors in the group’s bonds and the wealth management products that have provided much of its $US305 billion of liabilities has been left hanging.
The list of missed interest payments on Evergrande’s bond issues is lengthening, almost on a daily basis.
Beijing has pumped $US120 billion into its financial system in less than a fortnight while urging state-owned banks to lend more to property buyers and support the property sector but is yet to become directly involved in any attempt to rescue Evergrande.Credit:AP
While it came to some form of non-cash settlement with investors in a tranche of onshore bonds last month, it has missed interest payments of $US83.53 million and $US45.2 million on two offshore bond issues and, according to Bloomberg, failed on Monday to honour a guarantee on a $US260 million note issued by a related entity.
While there are 30-day grace periods on the bond issues that would push a default out to the end of this month, the loan to Jumbo Fortune Enterprises has none. The potential for a formal default that could trigger cross-defaults in other Evergrande bond issues is real.
Within a week the group also has interest payments totalling about $US148 million due on three more series of dollar bonds and more than $US1 billion of interest payments due by early January next year.
It has also missed payments on some of the high-yielding wealth management products it relied on heavily as a source of short-term funding, which has sparked protests from investors. It has tried to satisfy some of those investors by making token payments and by offering them heavily discounted apartments in lieu of cash.
China’s authorities appear to be trying to prevent Evergrande’s implosion from developing into a property market crash and social unrest, with the local government authorities being directed to do what they can to take over and complete the group’s unfinished developments and to prepare for “mass incidents,” or large-scale demonstrations.
Preventing contagion won’t be easy. The shares in other property developers have been diving and their access to the bank and wealth management channels for funding is being curtailed.
Other developers are missing interest and principal payments – Fantasia Holdings missed a Monday deadline for repayment of a $US205 million bond and Sinic Holdings has missed two interest payments – and property prices are sliding.
The combination of over-leveraged developers, reduced access to funding and large-scale uncompleted developments can be combustible. Australia experienced a very destructive property development and property-finance related crisis in the early 1990s.
Beijing, apart from directing local governments to intervene, has pumped more than $US120 billion of liquidity into its financial system in less than a fortnight while urging state-owned banks to lend more to property buyers and support the property sector, the core of China’s economy.
China’s authorities appear to be trying to prevent Evergrande’s implosion from developing into a property crash and social unrest, with the local government authorities being directed to do what they can to take over and complete the group’s unfinished developments and to prepare for “mass incidents,” or large-scale demonstrations.
It has yet, however, to become directly involved in any attempt to rescue Evergrande, instead trying to influence the rate of its collapse and contain, to some degree, its fallout.
The authorities want to reduce the degree of leverage in the sector – it was their own deleveraging policies that cut off Evergrande’s access to funding and ignited the crisis – and rid themselves of the moral hazard associated with previous bailouts of stated-owned enterprises or companies deemed too big to fail. They’ll have no sympathy for foreign banks or bond holders.
The impact of Evergrande’s woes on China’s shadow banking may represent a challenge for the authorities. The sprawling non-bank finance system was the major source of funding for China’s property boom and bubble over the past several decades but especially since the global financial crisis in 2008.
If Evergrande were to spark a run within that shadow system the authorities might have no alternative but to intervene more directly.
Evergrande’s asset sales will generate some cash and liquidity and enable it to meet some of the authorities’ priorities but the sheer scale and nature of its liabilities and the crisis-induced diminishing value of its assets means it won’t meet all of its obligations or contain the wider fallout.
The challenge for the authorities will be to confine the losses to foreign bond holders and wealthy local investors while avoiding systemic problems and a broader collapse in property values and among key industry participants.
The command and controls nature of China makes that task easier than it might be if it occurred elsewhere but still doesn’t make it easy.
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