China Crumbles

Xi's economic miracle is running into serious problems. Now the property market contagion is spreading to the shadow banking sector, and authorities are panicking on what to do.

Chinese real estate losses are beginning to hit harder, and banks are reeling from the damage. The Asian behemoths’ housing sector may finally be on the brink…

A few months ago, I wrote an in-depth piece on the property woes that China was facing as overleveraged developers, bad loans, and poorly built apartments all conspired to begin a crisis in the country’s real estate market. Of course, finding the real data on what was happening within the Communist nation was difficult as Chinese government agencies are notorious for hiding, obfuscating, or just fabricating economic data in a bid to show a stronger front than what actually exists.

But the situation appears to be deteriorating.

In October, existing home prices experienced their most significant drop since 2014, coinciding with the first-ever decline of outstanding property loans, as noted by Larry Hu, the chief economist at Macquarie, in a Friday statement.

This signals heightened pressures affecting both demand and supply in the housing market. While existing policies have emphasized bolstering demand, the Macquarie report highlights a crucial problem: the government's abject failure to tackle the paramount concern of credit risk associated with developers in the real estate sector.

“Without a lender of last resort, a self-fulfilled confidence crisis could easily happen as falling sales and rising default risks reinforce each other. Indeed, some large developers have recently seen their credit risks rising rapidly.”

This comes after the August turmoil that resulted in Evergrande going into forbearance on its debt obligations and then officially declaring bankruptcy, and Country Garden missing multiple payments on offshore dollar bonds. Since then, Evergrande has entered bankruptcy proceedings but luckily has been offered the chance to negotiate terms with creditors and investors.

Last Monday, a Hong Kong bankruptcy judge granted Evergrande an additional two-month window to negotiate a resolution with foreign investors who faced losses after the company defaulted with debts amounting to hundreds of billions of dollars two years ago. The judge scheduled another court session for January 29th.

This development unfolded within a bankruptcy lawsuit initiated 18 months ago by an investor so desperate for compensation that he sought to basically dismantle Evergrande. Judge Linda Chan had said in October that she was prepared to order Evergrande's liquidation if no agreement was reached among its creditors regarding the division of the company's remaining assets.

Evergrande had borrowed more than $300B in a massive bid to develop huge swaths of real estate. Much of its revenue at the time came from a practice of pre-selling properties, that is, selling units that hadn’t even been built yet! This was commonplace in China, where stringent capital controls and general public distrust of the banking system has pushed hundreds of millions of Chinese into the real estate sector in an attempt to protect savings and earn a decent interest rate. (I had written about this in an early piece here).

Country Garden has also been trying to wade out of the financial depths it has caught itself in. In August, it had neared default on several different offshore dollar bonds, surviving by delaying payment and then seeking remediation in court. However, it had been unable to keep up with the massive cash payment demands of its debt and was squeezed by the rapidly contracting housing sector. By some measures, home values have fallen by more than 20% in some major cities as the Chinese economy rolls over and debt loads for households become unserviceable.

Last week, the brutal realities of Xi’s brand of capitalism came to bear-

Reuters reported that the company was able to pay $111M to repay ONSHORE bond holders- i.e. Chinese investors. All offshore (foreign) creditors continue to wait for payment of the bonds, and Chinese courts are not known to be particularly sympathetic to the financial desires or rights of foreigners. 

Country Garden's repayment arrives amid its default on a total of $11 billion in offshore bonds, prompting the company to strategize a debt restructuring plan. In September, the company had successfully secured creditors' approval to prolong the maturity timelines of eight onshore bonds totaling 10.8 billion yuan by an additional three years- kicking the can further down the road.

Moody's unexpected downgrade of China's credit outlook last week has now heightened worries that the turmoil in the nation's real estate sector is spreading to impact the broader economy, including the banks.