MRP has covered growing bubbles in China’s real estate market and financial sector for several years now. The ongoing collapse of Evergrande Real Estate Group is the latest symptom of runaway speculation, and a broader weakness that now appears to be gripping the Chinese economy.
Evergrande is China’s second largest property developer by sales, the leading issuer of high-yield notes in Asia, and the world’s most indebted property developer. With shares of the company breaking down to a new low on Tuesday morning, the firm has a market capitalization of about $3.9 billion. That compares to $90 billion in debt on its balance sheet, and $300 billion when including unpaid bills.
Fears of an imminent default have vaulted Evergrande into global headlines over the past couple of weeks, as they were scheduled to pay interest on bank loans on Monday, with a one-day grace period. Since Monday and Tuesday are public holidays in China, we may have to wait until Wednesday for a resolution. However, Chinese authorities have already told major lenders not to expect repayment.
More tests of Evergrande’s liquidity are set for later this week, with the group due to pay $83.5 million of interest on an 8.25%, five-year dollar bond. Though the Sydney Morning Herald notes that the bond’s covenants stipulate a 30-day grace period before that missed payment would technically be considered a default, the writing will be on the wall if no liquidity can be supplied quickly. Evergrande will also need to pay a coupon worth $50 million on an onshore bond that same day.
Additionally, it has another $47.5 million payment due on September 29 for March 2024 notes. In total, Evergrande owes a whopping $669 million in coupon payments coming due through the end of this year. Unsurprisingly, Moody’s Investors Service and Fitch Ratings have each downgraded Evergrande this month, indicating an increasing likelihood of default on the horizon.
Macro strategists at Swiss bank UBS have noted that they now view a credit default as unavoidable. Should total liquidation happen, the spillover would be significant, and the bank’s strategists say a “high degree of contagion” is expected. Barron’s notes that a domino effect of other defaults could be initiated, because both banks and other groups with large exposure to Evergrande face the threat of bankruptcy or restructuring.
S&P Global Ratings says support from the Chinese government appears to be unlikely – but they are less concerned with contagion. Per an S&P report from yesterday, “We believe Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy… Evergrande failing alone would unlikely result in such a scenario.”
While analysts across the world are split on how widespread the damage from an Evergrande default would be, at least one other property developer is already being dragged down alongside it. Hong Kong listed shares of Shanghai-based developer Sinic Holdings Group Co. cratered 87% lower before being halted Monday, the first major sign of contagion spreading across China’s real estate sector. It was a week ago that Fitch revised its outlook on Sinic to negative, but the Evergrande fiasco drove a renewed wave of panic regarding Sinic’s own potential default next month. Per Yahoo Finance, the group has a 9.5% $246 million bond due on October 18.
Some are skeptical of how systemic this credit event could be, pointing out that Evergrande’s debt represents just 6% of the total for the county’s property sector and only around 4% of market share in a highly fragmented Chinese real estate market. However, as we can see with Sinic, other assets could be heavily affected by a blow-off in sentiment alone.
Domestic real estate represents a significant contagion threat to the economy as a whole, since extremely low property taxes have made the sector a particularly valuable asset for all levels of Chinese society. As Foreign Policy Magazine reports, most businesses in China are to some degree real estate businesses, investing in property on a grand scale. The Chinese middle class is also heavily invested in real estate projects. Chinese household debt has ballooned to 62% from 39% of GDP since 2015, largely through residential mortgages, Larry Hu, head of China economics at Macquarie Group, recently told Barron’s.
Overwhelming asset demand for property has continually driven an ever-inflating bubble of empty apartment complexes and other real estate ventures throughout China.
Perhaps portending the now unfolding collapse of Evergrande was video of last month’s mass demolition of 15 unfinished high-rise buildings in Kunming, the capital of Yunnan province – and what likely would have been home to one of China’s infamous “ghost cities’; whole neighborhoods full of vacant apartment complexes. Vice reports that authorities count 93 unfinished property projects throughout Kunming.
As has been the case with Evergrande, Chinese real estate developers often auction off apartment buildings in pre-sales years before construction finished, using those revenues to fund construction. Due to massive saturation of the real estate market throughout the country, however, there is little demand from anyone to actually live in these properties, causing cash to dry up during development or not long after.
Research firm Capital Economics estimates that Evergrande has pre-sold more than 1.4 million apartments valued at $200 billion that it has yet to finish.
As Jim Chanos, president and founder of Kynikos Associates, told CNBC this week, the residential property market is equivalent to 20% of China’s GDP, while real estate activity in general is about 30% of GDP. He added that China has tried to stem the speculation in its property market four times since 2011, but the resulting stagnation in economic growth has always made regulatory authorities back off.
If property investment is severely dented by Evergrande’s breakdown and the resulting fallout, we could see Chinese GDP estimates start getting cut. Some downward revisions have already come out. Bank of America Securities said today that its new real gross domestic product growth forecast for China has been trimmed to 8.0% from 8.3% for this year, 5.3% from 6.2% in 2022 and 5.8% from 6.0% for 2023.
Christophe Barraud, chief economist at Market Securities LLP (and Bloomberg’s top-ranked forecaster for the Chinese economy last year), sees just 0.3% growth in the July-September period from the previous three months, below the median estimate of 1.1%. As he told Bloomberg this month, growth “should be close to 8% but with risks tilted to the downside.”
Whether or not Evergrande ends up in bankruptcy, restructuring, or a bailout, China’s overdeveloped, highly speculative property market can no longer fly under the radar and is likely to leave a bad taste in investors’ mouths for some time.