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EverGrande -- the wheels are starting to fall off

 On Friday, September 9, 2022 the headquarter of Evergrande in Hong Kong was seized by foreign creditors.  It is possible that the Chinese government decided that it was not worth the trouble to fight for that one piece of real estate, especially if it was owned by a single creditor (unknown at this stage). 

My Friends in China tell me that the government is fully aware of the scope of the problem they face with mainland real estate and are threading a needle.  The problems are several, but the first and most important is the deal to restructure Evergrande which will be the blueprint for the other Chinese real estate companies that are facing nearly identical cash flow problems.

The amounts are too large for the state to absorb.  Evergrande's total debt outstanding is around US$ 300 billion.  Evergrande is not the largest real estate developer.  The 300 billion is used as equity in projects worth between 5 and 10 times that amount.  These are the borrowings from ordinary Chinese that have purchased apartments that have yet to be completed. The Chinese problem is that if it makes the bondholder whole (and they do have a priority call on the assets of Evergrande), the Chinese government has to consider that it would also have to make whole the individual investors -- that have purchased the units yet to be built.

Factors that China must consider:

  1. How much money are we talking about
  2. What percentage of bondholders are really foreign
  3. How many more developers are in trouble
  4. How will bank lenders react

These are all tied together.  (1) There is no concept of audited accounts in China, there are no auditors so the Chinese government has to send its own teams to each company and figure out where things stand.  That takes time, and China is running out of time (re. the seizure of Evergrande's headquarters in Hong Kong is an example).  (2) Many Chinese have used foreign accounts to invest in China -- as a way of reducing mainland exposure and these may be powerful interests -- again unknown, but this is Chinese wealth that would also be destroyed.  (3) The crux of the Evergrande restructuring, is the total numbers, and the Chinese are apparently only now discovering the scope of indebtedness.  The wealth of all Chinese is based on real estate, the price bubble for Chinese real estate is a magnitude greater than the 2008 US real estate bubble (e.g. average home price in Shanghai is 25x the average salary, it peaked at 10x in New York...), and (4) how will the banks react, their actions are driven by the Chinese government too, with tightening restrictions on real estate lending. 

But as the wheels seem to be coming off in the real estate front, there is probably no easy solution here.  First, is that whatever the government chooses it will create pain in parts of the economy.  The slow and steady hand progress that has been deployed since January is probably no longer working, especially with foreign bondholders.  It is unclear what recourse the bondholders have, but somehow I suspect that they will not go quietly.  

Those who can seize assets are beginning to do so, others will have to absorb their losses.  It may be advantageous for the Chinese to completely disenfranchise the foreign bondholders, it worked for Argentina, so why not for China too. 

As the Chinese proverb says:  May you live in interesting times!


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