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Risk for China's Financial System? Evergrande Stock Tumbles

China's Financial System
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EDITOR NOTE: Perhaps you’ve never heard of the China Evergrande Group, but in 2018 it was the world’s most valuable real estate company. Evergrande has its finger in many businesses besides real estate but selling property remains its bread and butter. The company has seen dire financial straits before but has always managed to emerge from its crises relatively unscathed. Garnering favor from the Chinese government, and faith among Chinese and other international investors, it remains on the Global Fortune 500 list as one of the top 10 developers in China. Well now, it’s overextended itself and once again faces serious default risk. It also appears that the Chinese government and investors are beginning to lose faith in the company. Its liabilities are so large that if it collapses, the wreck will trigger contagion across China’s financial system. Interestingly, and pivoting a bit, Evergrande serves as a cautionary tale for the US--the overextension, the overconfidence, and the consequences of declining confidence. The lesson for us Americans pertains not to any single US company, but the federal government, Federal Reserve, and the monetary and fiscal recklessness that may be fueling the firestorm that’s about to burn the entire house down. 

(Bloomberg) -- Fresh signs of a cash crunch at China Evergrande Group sent shares and bonds of the world’s most indebted developer to new lows on Tuesday, stoking fears of broader market contagion.

The property giant’s stock tumbled to the lowest level since April 2017, extending its two-day loss to 25%. Several of Evergrande’s local and offshore bonds sank to records, with its dollar note due 2025 falling to as low as 54 cents. Bonds of other junk-rated Chinese borrowers declined, while a gauge of developer shares dropped to a nearly three-year low. The nation’s bank stocks also slumped.

Long-simmering doubts about Evergrande’s financial health intensified this week after the developer had a $20 million bank deposit frozen by a local court and was hit with a sales ban by a city government alleging it failed to set aside enough funds in escrow accounts. The city later removed the ban, providing some relief for Evergrande’s stock, but investors remain worried the company isn’t selling properties and other assets fast enough to repay its $301 billion mountain of liabilities.

“Evergrande’s debt risk is quickly piling up,” said Ma Dong, a partner at Beijing-based bond fund BG Capital Management. “The size of the frozen assets is small, but investors are concerned that more creditors will take similar actions.”

While Evergrande has emerged from past liquidity crises intact, some investors are betting this time will be different as Chinese President Xi Jinping’s government becomes more tolerant of defaults. Several large state-owned banks have already reduced their lending to Evergrande, though the developer has repeatedly said its relationships with creditors are normal. The company arranged payment for $352 million of dollar-bond coupons on Tuesday, Cailian reported, without citing anyone.

The risk is that a major payment failure at Evergrande ripples through China’s financial system, eroding confidence in other highly leveraged property companies, shadow lenders and even some banks. Officials from China’s top financial regulator told Evergrande founder Hui Ka Yan at the end of last month that he should solve his company’s debt problems as quickly as possible, emphasizing the need to avoid major economic shocks, people familiar with the matter told Bloomberg News earlier this month.

The frozen bank deposit has some creditors questioning whether Evergrande still enjoys the implicit support of Chinese authorities, said Omotunde Lawal, head of emerging-market corporate debt at Barings UK. “The key thing to watch now is if other banks or trust companies rush to demand loan repayment or freeze assets,” Lawal said, adding that any news of successful asset sales by Evergrande may help calm investor nerves.

Bloomberg reported on Monday that Evergrande is considering an initial public offering in Hong Kong for its bottled water business, though the sale would only raise a few hundred million dollars and take place next year. The Shenzhen-based developer has some $80 billion worth of equity in non-property businesses that could help generate liquidity if sold, Agnes Wong, a Hong Kong-based analyst with BNP Paribas SA, wrote in a June report.

Whether Evergrande can secure attractive prices for those assets remains to be seen. All of its key listed units have tumbled in recent weeks, with the market value of Evergrande Property Services shrinking by as much as $17 billion since its February high. Evergrande New Energy Vehicle lost as much as $60 billion in the period.

This week’s rout began on Monday morning, after traders circulated a court ruling on a loan dispute between Evergrande and China Guangfa Bank Co. The court froze a 132 million yuan ($20 million) deposit held by Evergrande’s main onshore subsidiary, Hengda Real Estate Group, at Guangfa Bank’s request.

Late Monday, news emerged that the Chinese city of Shaoyang had halted sales at two of Evergrande’s residential projects. Shaoyang’s government said it took the action after Evergrande didn’t deposit enough pre-sale funds into escrow accounts and intentionally evaded supervision, according to a statement posted on the local housing department’s website.

On Tuesday, Shaoyang authorities said they had allowed Evergrande to resume sales at the two projects after the developer transferred more money into the accounts.

Chinese developers sell residential properties before construction is completed but are required to deposit funds from the transactions in supervised bank accounts. These escrow accounts are designed to prevent cash-strapped builders from abandoning projects.

The incidents suggest negative sentiment toward Evergrande has spread “beyond short sellers to local officials and banks,” said Brock Silvers, chief investment officer at Kaiyuan Capital in Hong Kong.

Evergrande’s stock, which sank as much as 16% on Tuesday, pared its decline to 10% at the close in Hong Kong. It was still the biggest loser in the Hang Seng China Enterprises Index. The Shanghai Stock Exchange Property Index slid 0.5% to the lowest since October 2018, while developers led declines among China’s offshore junk bonds. Notes issued by Kaisa Group Holdings Ltd. and Guangzhou R&F Properties Co. fell between 1.6 cents and 2.4 cents on the dollar.

Evergrande has a history of “pulling a rabbit out of a hat in terms of financing,” said Nigel Stevenson, an analyst at GMT Research Ltd. “The problem is if that confidence ebbs away, people start looking out for their own interest and grabbing whatever they can. That’s the danger of things unraveling quite quickly.”

Original post from Yahoo! Finance

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