Recent events surrounding Chinese property developer Evergrande has spawned much discussion about whether a bankruptcy or full government bailout is on the cards. What’s in store for Chinese real estate?
November 2018: The People’s Bank of China labels Evergrande a financial conglomerate capable of creating systemic risk. Fast forward to today: an IPO, a terminated backdoor listing, and multiple ratings downgrades later, Evergrande teeters on the brink of default.
Angry retail investors flood it’s Shenzhen headquarters as the company grapples with the repayment of its bonds and wealth management products, spooking investors from all corners of the globe.
Evergrande singlehandedly amassed debts of over US$300 billion — the equivalent of 2% of Chinese GDP, and the ripple effect is clear. During China’s “Golden Week” in October, MERACYC, China’s high-yield US dollar-denominated debt index mostly made up by real estate issuers fell to a five year low. Hong Kong’s Hang Seng Index also hit a ten month low within the week. Adding to the woes, Fantasia Group Holdings, another Chinese property developer is downgraded to ‘default/near default’ status shortly after by the three top ratings agencies after the company fails to make good on a bond.
At this juncture, the Chinese government has a balance to strike. On one hand, it can be bastion of investor protection to those whose life savings are tied up in unfinished flats, to unpaid contractors and suppliers, and to the wider investment community. And on the other hand, overleveraging by developers has been a major headache for policymakers — so, does the government provide immediate liquidity relief, or let a market correction unfold, rocking primarily debt markets in the short-term, but planting the seeds for a more sustainable real estate sector?
Three red lines
The common thread of constricted liquidity and reserves running through Evergrande, Fantasia and potentially Sinic has partially been brought about by Beijing’s “three red lines”, which set caps on developers’ liability-to-asset ratios, net gearing ratios and cash-to-short-term-debt ratios. These were introduced to reduce leverage, combat rising land prices and explosive property sales.
Under these new conditions, it has become increasingly challenging for debt-fuelled developers to keep their heads above water. Furthermore, in Evergrande’s case, much of its war chest of cash was being spent offshore, which is not conducive to domestic growth. The three red lines would unlikely have been put forward without any anticipation of the results.
No Lehman moment
Initially, as murmurs of Evergrande’s collapse surfaced in September 2021, there was much talk of a government bailout. Parallels were being drawn to Lehman Brothers 2008. But, authorities in Guangdong had already turned down one bailout request, and the Chinese government has so far been relatively passive as the company crumbles more with each missed bond repayment.
According to S&P Global Ratings, despite its magnanimity, the Chinese banking system and wider economy is unlikely to suffer deep or long-lasting consequences should Evergrande fold. This is echoed by Aaron Costello, Managing Director of Global Investment Research at Cambridge Associates, who flagged HNA Group, Wanda, Anbang and Huarong as past examples of sizeable companies whose troubles did not create lasting damage to the wider economy.
Greater financial discipline needed
Costello also believes that the government is likely to adopt a strategy which combines a “forced” restructuring with the extension of an occasional olive branch — a state owned asset manager recently bought a US$1.5 billion stake in Shengjing Bank from Evergrande.
Analysts from S&P Global Ratings don’t foresee a full bailout being on the cards, claiming that such a move would “undermine the campaign to instil greater financial discipline in the property sector.” If this is what the Chinese government has in mind, it may not be too displeased at this purging exercise, which will eliminate the overly risk-seeking players, provided there is no spillover to other industries.
As it stands, demographics are painting a murkier outlook for Chinese real estate, especially in the residential sector. Urban population growth has slowed alongside a decline in marriages, leading to what Capital Economics’ Senior China Economist Julian Evans-Pritchard has called an “era of protracted structural decline.”
But this bearish view doesn’t apply to the entire Chinese real estate ecosystem — especially prime-located retail assets and logistics properties. Beijing’s push to launch REITs — a considerable number of which focus on the industrial and logistics sector — and aggressive stimulus to infrastructure projects suggests it has different plans for other asset classes, and residential properties may just be an anomaly.
Among Evergrande’s largest international holders are the likes of Amundi, BlackRock, Goldman Sachs, HSBC UBS. So what’s the common denominator here?
None of these are Chinese banks. Unlike the Lehman crisis in 2008, which took place in a system where the livelihood of the “corporatocracy”, and where the needs of the West’s largest financial institutions seemingly prevailed over the needs of the man on the street, “common prosperity” has been a cornerstone of Chinese policy over the last decade.
Therefore, while the short-term contagion and placebo effect of panic selling in the markets will leave investors burnt, Chinese policymakers may just be thinking about long-term housing affordability for the masses.
As China transitions away from an era of rapid growth and economic reform, it is more likely the government will prioritize sustainable growth within the existing framework rather than direct resources toward already overleveraged and runaway growth sectors — be it real estate or not.
The Chinese government does, after all, have sufficient dry powder in its artillery to re-engineer the economic landscape — by reinvigorating sectors and individual firms that may face a short-term cash crunch as a result of Evergrande’s demise.