What a Collapse of China’s Evergrande Would Mean

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by Wolf Richter, Wolf Street:

China hasn’t bailed out its over-indebted property developers yet, to the shock of foreign investors who’d bought their dollar bonds. Could the forced deleveraging trigger a financial crisis?

Property development has been a huge factor in China’s economic growth. It accounts for 28% of GDP. And much of it has been funded by debt, including dollar-debt, and much of it is now blowing up.

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Foreign investors piled into the property sector over the years, buying hundreds of billions of dollars in bonds, including dollar bonds issued by China’s property developers. They bought those bonds because they liked those yields, in some cases over 10%, thinking that the Chinese government wouldn’t let those companies default, that it would bail out the bondholders as it bailed out so many bondholders before, and surely it would do it again, given how crucial the funding of the property sector is to the Chinese economy.

And now just about everything has gone wrong for these foreign investors. For months, there has been a massive crackdown by Chinese authorities on liquidity-driven inflows into the housing sector.

Authorities cracked down on overleveraged property developers. They targeted mortgage approvals and interest rates for first-time buyers. They tamped down on rental growth. They pushed banks to reduce their lending to homebuyers. A national property tax has been put on the table.

And this was topped off with an increasingly strained relationship between the Chinese government and the United States government, that includes major steps by the US government to crack down on speculation by Chinese entities in the US stock markets.

China’s crackdown on property speculation is guided by the official mantra that “housing is for living, not for speculation.”

That massive amount of speculation and leverage has for years posed enormous risks to financial stability. And the government is now trying to defuse those risks – and it looks like at the expense of foreign investors that have bought those hundreds of billions of dollars in bonds.

Those foreign investors are suddenly realizing that they’re no longer sacred and that the government may not bail them out.

Bailouts had been taken for granted, given how important the property sector is to China’s economy, and foreign investors whose money was needed to fuel that property speculation, had felt secure in their thinking that China would bail out those bonds if push came to shove.

Now push is coming to shove.

Evergrande Group, the second largest property developer in China, and the property developer with the most debt in the world, owes banks, shadow banks, other companies, investors, its suppliers, contractors, and home buyers $305 billion, according to Bloomberg.

It hasn’t been able to sell a single dollar bond since January 2020, and has no prospects of doing so as foreign investors have gotten the message.

On August 31, it said that work was suspended on a number of real-estate projects after it delayed payments to its suppliers and contractors. It warned that it may default on its debts if it can’t raise new money.

If it was difficult to raise new money before, it became impossible after that announcement – unless the government steps in, and that hasn’t happened yet.

On September 7, Moody’s and Fitch downgraded Evergrande Group and a number of its entities deeper into deep-junk, to ratings that indicate that a default is imminent with little recovery for investors in those bonds.

Moody’s said that the downgrade reflects the company’s heightened liquidity and default risks given its large amount of debt that will mature over the next 6-12 months.

Since Evergrande does not have enough cash to pay off the debt that matures over the next 12 months, it has to raise new money to pay off those old investors. If it cannot raise new money, either by issuing new bonds, or by borrowing from banks, or by selling assets that are not already leveraged to the hilt, it will default on those maturing bonds.

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