Investors are holding their breath as the world witness the gigantic China property bubble deflate. Last week all eyes are on Evergrande to see whether China’s most indebted developer will default. The company is due to pay US$83.5 million in interest on September 23 and another US$47.5 million on September 29.
It is nothing but a dead cat bounce
A day before the payment deadline last Wednesday, founder and chairman Hui Ka Yan reassured investors that he has already resolved payment of the offshore bond through private negotiations.
However, he didn’t mention when and how much payment would be made. As of today, there was no further announcement or filing with the Hong Kong stock exchange, leaving Evergrande investors in the dark.
Hui’s act is no different from debtors when they are being pressed by loan sharks. You ask them to give you a bit more time, at most a week, and you will surely repay what you owe. The truth is: If you really had the money, you would have settled your debt long ago.
Nonetheless, the market saw this as a silver lining. Shares of Evergrande jumped 17.6 percent last Thursday. This was remarkable, considering the company’s share price had dropped over 80 percent this year. At the very least, a dead cat bounce opened a window of opportunity for investors to sell and exit in time. The next day when the market saw nothing had been done to save the situation, share price plunged again.
How we define asset bubbles
A bubble is defined as an extraordinary booming of economic activity in an asset market, characterized by rapid escalation of price or market value. A bubble often ends in a sudden collapse of the asset market.
Different people define bubbles differently. Industry stakeholders generally don’t have this term in their dictionary. In the equity market, investment banks, analysts and brokers call bubbles hot stocks. Likewise, in the real estate market, mortgage banks, developers and agencies call bubbles hot properties.
To me, if a company loses millions or billions every quarter and fails to make any profit for years, yet still has sky-high bank valuation, rounds of massive investor fundings, and high-profile record-breaking IPO, it is an equity bubble.
Similarly, if real estate prices grow out of reach of the actual users, but developers still continue to build like there is no tomorrow, it is a property bubble.
Think people who are drunk insist that they are not drunk. Industry stakeholders swear there is no market bubble. Investors are only making hay while the sun shines. Speculators don’t admit that they are speculating. They may have no idea what they are buying into. But they have strong faith that prices will continue to climb.
Foresight is far better than hindsight
As serious investors, we value foresight or insight, not hindsight which is not very useful. We prefer to highlight bubbles when they are forming, not when they are about to burst or have burst.
Under easy onshore and offshore borrowings, total debts of Evergrande exceeded US$300 billion (S$405 billion). Ironically, it was not until this July and August that Moody’s, Fitch and S&P downgraded the ratings of this “too big to fail” property giant.
In 2018, while other media were busy covering property record sales and were very upbeat about the real estate market, guess which media reported the unhealthy leveraging of Chinese developers? They are South China Morning Post, Reuters, CNBC and Financial Times.
In this blog, my 2017 blog post mentioned China’s shadow banking system and how Chinese developers replicated their borrowing tactics in overseas projects. (Read comments in “Chinese developers: Who exactly are they?”, Propertysoul.com). The following year we shared the unending leverage game and cashflow problems of Chinese developers in “4 things Country Garden’s hiccups tell us about developers”.
For readers who follow my Property Soul facebook page, we put the huge debts of Chinese developers under the spotlight since 2017. Back then, interest for these posts was not high. It is a big contrast to the recent high number of views for Evergrande-related posts.
Developers crossing the 3 red lines
The Chinese government has been trying to tackle the overheated real estate market from mid-2017. However, every time when the authority tried to tighten borrowing, it intensified the cashflow crisis of highly leveraged developers. The government had no choice but to loosen the noose at the most critical moment to avoid casualties.
But whenever developers got new breath of air, they borrowed more and bid higher in land auctions. After domestic financing options were not available, they went abroad to raise cash. Overseas financial markets welcomed their offshore bonds. After all, any investment in China and any asset related to real estate were highly regarded by the analysts as “hot”. That’s how the China property bubble ballooned to US$52 trillion.
Last August, after three years’ of futile efforts to cool the real estate market, President Xi Jinping grew impatient. He imposed the three red lines on credit ratings of major developers. Those who failed were forbidden to borrow.
1) Liability-to-asset ratio (excluding advance receipts) of less than 70 percent
2) Net gearing ratio of less than 100 percent
3) Cash-to-short-term debt ratio of more than 1x
A dozen developers, including Shenzhen-based Evergrande and Vanke (developer of The Glades in Singapore), and Guangdong-based Country Garden (developer of Forest City and Danga Bay in Johor Bahru), were picked for a pilot scheme to submit three-year debt-reduction plans.
Below is the latest chart dated September 2021 showing the report card of all major Chinese developers.
Besides Evergrande (恒大), Beijing-based Huayuan (华远) and Guangzhou-based R&F (富力) (developer of R&F Princess Cove in Johor Bahru) failed all three red lines. Country Garden (碧桂园) has crossed the liability-to-asset ratio red line and is now in the yellow zone. Tianjian-based Sunac (融创) (won the Sino-Singapore Tianjin Eco-City site last year) has been moved from red to yellow zone. But its shares are now being sold off heavily as it is considered the next liquidation target after Evergrande.
Possible contagion from the Evergrande and China property crisis
The Evergrande crisis is only the tip of an icerberg. There are at least six parties which may be hit hard by the possible burst of the China property bubble:
1. More developers will go under if prices slump and property market collapse
It is not uncommon for Chinese developers to slash prices of local and overseas projects to raise cash. Evergrande had once offered 30 percent discount and sold 141.63 billion yuan (S$30 billion) of properties in 38 days in order to generate cash to repay debt.
A Shanghai Pudong is now giving 20 percent. At least eight cities have come up with measures to stop developers from offering excessive discounts to prevent collapse of the property market.
As of September 5, a total of 274 developers filed for bankruptcy in China this year. That means there is one developer going under every day. Many are big and well-known developers.
2. Homebuyers of uncompleted projects from debt-ridden developers
There will be more development left unfinished by bankrupt developers. Chinese developers are infamous for building ghost towns. Vacant properties in China can now accommodate over 90 million people. There is an online video showing 15 half-completed high-rise towers in Kunming being blown down by explosives.
In Hong Kong, two Evergrande projects Emerald Bay and The Vertex will be handing over completed units to the owners end of September and October. Last week the developer suddenly informed the buyers that the financing arm of Evergrande could no longer offer them the promised 90 percent loan-to-value. Rumors had it that major banks in Hong Kong took the lead to reject mortgage applications from these buyers. Other banks are likely to follow suit. Now the buyers are left with two choices: Pay in cash for 90 percent of the property price or forfeit their 10 percent downpayment.
Under the Black Swan of the subprime crisis in 2008, banks in Singapore tightened lending to property buyers who bought off-plan properties. They suddenly offered lower LTV or withdrew previously approved loans. Many homebuyers bought at high prices in 2007 and were caught totally unprepared. With the decline in valuation, they could not find any bank loan to match their original purchase price. They were asked by their banks to put in more cash to secure financing. When they couldn’t raise the money, they were forced to dump their properties in a depressed market.
– Vina Ip, Behind The Scenes of The Property Market
3. People’s wealth affected by devaluation of their homes
Property investment accounts for two-thirds of Chinese household assets. Drop in value of properties will impact millions of home owners. Net worth of the newly rich and the middle class boosted previously by real estate will diminish with the deflating property bubble.
4. Chinese and global suppliers and importers hurt by abrupt market slowdown
Real estate sector accounts for about 29 percent of China’s GDP. It contributes significant revenues to banks, property-related industries, corporate investments, and the central and provincial governments.
In particular, unpaid suppliers of Chinese developers are likely to face cashflow problems. A cooling real estate market will impact both domestic and global suppliers. A sharp slowdown of China’s economy will also affect demand for imports and hurt the economy of China’s biggest importing countries, namely Japan, Korea, US, Australia and Germany.
5. Chinese and global investors exposed to the China property bubble
Evergrande Chairman Xu’s wealthy poker friends were quick to cut loss with massive sell-off of the developer’s shares and bonds. Yet there are tons of high-yield fixed-income products linked with Evergrande sold through shadow banks to wealthy clients.
On September 13, Evergrande investors staged protests in front of the developer’s Shenzhen head office to demand repayment of loans and financial products. Potential defaults of other Chinese developers are going to affect social stability.
This is just inside China. We haven’t touched on countless foreign holders of Evergrande and other Chinese developers’ stocks and bonds that keep falling in prices.
6. Global and local banks exposed to Evergrande and China’s real estate market
Morningstar just disclosed that BlackRock, Royal Bank of Canada’s BlueBay, UBS and London-based Ashmore are exposed to Evergrande Group. TCW and HSBC funds have closed positions. How many more are hiding their China real estate exposure and bad debts?
Many banks have over 40 percent of their assets exposed to the real estate sector. The crisis will potentially spread to the global financial system.
The last financial crisis did not only cause the collapse of Lehman Brothers, Fannie Mae and Freddie Mac. Wiki lists 85 banks worldwide bankrupted, acquired or merged during the aftermath of the subprime crisis.
How safe are the banks now? Are there banks too big to fail? How many governments can bail out the financial institutions in their countries if they get into trouble in the next financial crisis?
– Vina Ip, Behind The Scenes of The Property Market
Food for thought
Three weeks ago, US private equity giant Blackstone scrapped its planned US$3.05 billion acquisition of Beijing’s biggest developer Soho China. Shares of Soho China immediately tumbled 35 percent. Well before that, the couple founders had been accused of fleeing to the US after selling billions of their assets.
In fact, investors who know the China market well have fled like lightning or seeing ghosts. Really, it is unnecessary to wait till writing off US$1.78 billion and getting back only one dollar in return as in the CDL Sincere deal.
Yesterday DBS chief executive said he did not see the Chinese developer crisis as a systemic risk to the region’s banking industry. IMF and investment banks such as ING and Macquarie were also quick to point out that Evergrande is not China’s “Lehman Moment”.
I can still recall Donald Trump’s first Covid-19 comment on 22 January 2020.
“It’s one person coming in from China. We have it under control. It’s going to be just fine.”
If you need advice on property matters or residential properties in Singapore, you can check out my personal consultation service.
My new book Behind The Scenes of The Property Market is now available for preview and order online. You can also check out my online courses.
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