China Could Eye “Controlled Detonation” for Troubled Developer Evergrande
No, the probably pending
China Evergrande Group
bankruptcy is not Beijing’s Lehman Brothers, as some headline writers suggest. Yes, it does mark a turning point for perhaps the hottest property market in history, and developers will struggle with longer-term shifts.
With $300 billion or so in outstanding debt, the voracious property developer has been an accident waiting to happen for quite some time. Two events late last week made the anticipated crack-up look imminent: The company unilaterally rescheduled payments to holders of so-called wealth management products, and Chinese regulators green-lighted Evergrande’s restructuring talks with banks and other large creditors.
The second move, at least, was a good thing, investors say. Debt negotiations will buy time for an orderly disintegration of Evergrande (ticker: 3333.Hong Kong), rather than an anarchic crack-up in a country with few big bankruptcy precedents.
“I’m more confident than at any time this year that this will be a controlled detonation,” says Samy Muaddi, lead manager for emerging markets corporate bonds at
T. Rowe Price.
“This is very far from testing financial stability in China.”
Evergrande’s prolific offshore borrowing make it a relative giant for the sub-culture of investors in emerging-market corporate bonds. Its place in China’s economy is more manageable. The sharpest problem for authorities is up to 1 million apartments the company has sold but not built yet, following common practice in China’s hungry property market. But the country built 6.45 million flats in 2019, indicating capacity to take over Evergrande’s abandoned projects.
“The government can bring in state-owned developers to protect these homeowners,” says Omotunde Lawal, head of emerging-markets corporate debt at Barings.
Evergrande racked up a lot of its debt from founder Xu Jiayin’s extravagant ventures outside property, from baby formula to electric vehicles and sports teams, Lawal says.
Its big real-estate competitors remained more disciplined, and investors can tell the difference. The real estate-heavy
KraneShares Asia Pacific High Yield Bond
exchange-traded fund (KHYB) has actually rallied 1.4% over the past six weeks as Evergrande’s troubles mounted.
“I was hoping for a sell-off that would provide more buying opportunity,” Muaddi says. Lawal remains comfortable holding bonds from developers like
CIFI Holdings Group
(884.Hong Kong) or
Sunac China Holdings
(1918.Hong Kong), with secure ratings at BB, toward the top of the junk category.
Not that Evergrande’s meltdown is occurring in a vacuum. “The entire Evergrande debacle was intended by the Three Red Lines policy,” says Tracy Chen, a portfolio manager for global credit at Brandywine Global. This refers to leverage limits the government laid down a year ago, which Evergrande struggled to comply with.
Competitors will be constrained in snapping up Evergrande’s assets lest they cross a red line themselves.
More fundamentally, Chinese leader Xi Jinping’s new push for “common prosperity” conflicts with developers’ most profitable business, building upscale apartments in affluent top-tier cities. The government is nudging the industry toward lower-cost and rental properties in ways subtle and not so: from manipulating credit to setting “reference prices” for real estate in the red-hot Shenzhen market.
This will expand elsewhere, Chen predicts. “The clampdown on the property sector is almost relentless,” she says. “Developers will be more like regulated utilities going forward.”
That’s not a great prospect for equity shareholders, but utilities are good at paying their bills. Don’t expect a wave of Evergrandes to follow the first one.
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