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Investors indifferent to intensifying Evergrande contagion risk

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For at least the past two years, anyone who’s been closely monitoring Chinese markets has been aware of China Evergrande’s distressed balance sheet.

The majority have remained indifferent about the mounting debt of China’s second-largest property developer, while a handful of pundits have warned of an impeding GFC-style meltdown.

We shared some of the latter views in an Asia Markets feature earlier this year. The article aptly titled China Evergrande: Subprime on steroids, the greatest threat to markets?.

Since then, the Evergrande crisis has been thrust into the spotlight through the headlines of the mainstream media.

Most recently, the company has missed consecutive coupon payments on U.S. bonds, while managing to meet some financial commitments owed to China mainland-based creditors.

So how bad is it right now?

The company has in excess of $300 billion in liabilities on its balance sheet.

That includes more than $20 billion in offshore debt.

There’s likely at least another $100 billion in off-balance sheet liabilities.

Coupon payments due on bonds in the remainder of this calendar year total $670 million.

And, next year… Well there’s close to $7.5 billion worth of maturing bonds.

It’s the staggering outcome of a growth-at-any-price mentality that has dictated Evergrande’s operations for much of the past decade.

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‘Liquidation’

Make no mistake, Evergrande – and more importantly the Chinese Government – is not sitting back and allowing this crisis to rapidly capitulate into a meltdown.

Just days after an executive at a state-owned Chinese enterprise told Asia Markets the Chinese Government would soon begin asking state-owned enterprises to buy Evergrande assets, the ‘buyers’ moved in.

State-owned Shenyang Shengjing Finance has purchased Evergrande’s stake in the Shengjing Bank for close to $1.6 billion.

State-owned Guangzhou City Construction Investment Group is reportedly taking control of construction of Evergrande’s Guangzhou Evergrande Football Stadium. It’s a giant project – the stadium has a 100,000-seat capacity.

Other state-backed enterprises including China Jinmao Holdings, China Vanke, and China Resources Land have also been linked to Evergrande asset sales.

However, the biggest asset sale to date has emerged in the past few days.

China Evergrande Group shares (HKG: 3333) and those of its property management unit, Evergrande Property Services Group (HKG: 6666), were suspended from trading on Thursday pending a major announcement.

Notably, shares in fellow Hong Kong-listed Chinese property developer, Hopson Development Holdings were also suspended around the same time.

Chinese media reports have revealed Hopson is poised to acquire around 51% of Evergrande Property Services Group for HK$40 billion.

Observers have viewed these developments as the beginnings of an effective “liquidation” of the Evergrande Group.

The aim – to to create a “soft-landing” for what many think will be the inevitable collapse.

Social unrest

In China, most of Evergrande’s apartment developments have stalled. Now there’s an estimated 1.5 million owners of those unfinished apartments who are angry.

Vision of public protests in China has been shared across the world.

The instability will undoubtably be making the Communist Party uncomfortable as it prepares for Xi Jinping’s transition into a third term.

This is why many believe the party will continue to demand Evergrande do whatever it takes for its expansive residential developments to resume – either under Evergrande’s ownership or the control of state-owned developers.

More asset sales that will support Evergrande’s ability to resume residential construction are expected.

“The key for Evergrande is to get project construction going and to sell inventory,” Gary Ng a senior economist at Natixis, told Channel News Asia this week.

“It (asset sales) is definitely a positive move towards solving Evergrande’s liquidity crisis and we expect more to come.”

Contagion

Fears of Evergrande contagion have intensified in recent days, after one of Evergrande’s competitors became the latest Chinese property giant to miss a major bond payment.

In a release to the Hong Kong Exchange on Monday, Fantasia Holdings Group (HKG: 01777) announced it had failed to repay a $206 million U.S. bond, and subsequently requested its shares be placed in a trading halt.

Evergrande contagion
Part of the trading halt request lodged by Fantasia Group Holdings on Monday, October 4.

There was more to come.

Later on Monday, Country Garden Services Holdings (HKG: 6098), notified the Hong Kong Exchange that it had not received repayment due on $108 million loan it provided Fantasia, and a default is likely.

Within hours of both announcements, credit rating agencies S&P, Fitch and Moodys cut Fantasia’s credit rating to a level suggesting the company is at, or near default level.

Fantasia has a further $1.9 billion in U.S. bonds and 6.4 billion yuan in domestic bonds due through the remainder of this calendar year.

While a smaller player in the Chinese property development market, Fantasia is a well-established conglomerate.

It was founded in 1996 by the niece of former Chinese vice-president, Zeng Qinghong.

Like Evergrande, it has a number of seperate business units, including property development and property investment, property agency services, hotel services, while it has also diversified into tourism, entertainment and interior design.

Another Chinese property developer, Sinic Holdings (HKG: 2103), has also been downgraded by credit ratings agencies in recent days.

Sinic missed coupon payments due on two yuan bonds last month, worth around $40 million.

S&P says it now thinks the company will default on a $246 million U.S. bond due on October 18.

“We lowered the rating because we believe Sinic has run into severe liquidity problems and its debt-servicing ability has almost been depleted,” S&P said in a note.

No panic, yet

Lim Chow Kiat, the CIO of Singapore’s $750 billion Sovereign Wealth Fund, GIC Private, shared his views on the Evergrande crisis at the Bloomberg Invest Global Conference on Tuesday.

“We believe that the problem has been quite well flagged. You might recall actually, for a number of years, China talked about the need to reign in financial leverage, on top of eliminating poverty, and environmental pollution. These are the three big evils that they had to tackle,” said Kiat.

“So, this is another case of that first big challenge that they’re trying to wrestle.”

“If you look at the balance sheet that the central Government has and the regulatory power, we think they have significant control over the situation.

“So we don’t expect it will be systemic, there will be some pain inflicted on certain segments of the value chain but we don’t expect it to come up and be a big systemic problem.”

Asked if he would consider investing in bonds issued by Chinese property developers, Kiat said he wouldn’t rule it out.

“Any market these days you cannot approach it on a top-down, broad basis. You have to deploy your team on the ground to do so (asses the investments).”

The views of the boss of a $750 billion Sovereign Wealth fund seem to be replicated in Asia markets and other global indices, which have broadly shrugged off Evergrande contagion fears.

So, much like the the past few years of the Evergrande demise, a sense of indifference appears to remain amongst many leading investors.

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