In China: High Stakes, High Drama

If you were already concerned about global growth and, specifically, a downturn in China, Wednesday offered little in the way of respite.

Activity data for August betrayed a marked decline in retail sales growth, not surprising under the circumstances perhaps, but disconcerting nevertheless. The growth rate “plunged from 2.8% to 0.7% in two-year CAGR terms, even worse than during the Chinese New Year period when there was another wave of local coronavirus outbreaks,” SocGen’s Michelle Lam and Wei Yao noted. “Apparently, more policy easing is needed, but the sanguine tone [from] the official interpretation of the August data seems to show little sense of urgency,” they added.

There’s a palpable “sense of urgency” around Evergrande, though. Beijing told lenders not to expect interest payments due next week, according to sources familiar with a meeting between the The Ministry of Housing and Urban-Rural Development and major banks. Apparently, Evergrande is also poised to miss a principal payment on at least one loan, a source told Bloomberg, whose coverage noted that it’s “unclear whether Evergrande intends to pay about $84 million of dollar-bond interest due September 23.”

Trading in Evergrande’s 5.9% local bond due 2023 was halted after it fell 21%. Its dollar bonds fell and shares plunged to the lowest in nearly eight years (figure below).

As noted here Tuesday, Beijing will almost surely guarantee completion of Evergrande’s sold projects.

Beyond that, the scope of the government’s involvement in what promises to be an absurdly complex cleanup effort is unclear. As Bloomberg aptly put it in the linked article (above), Evergrande’s “web of obligations to banks, bondholders, suppliers and homeowners has become one of the biggest sources of financial risk in the world’s second-largest economy.”

Goldman reckoned that recoveries in the company’s dollar bonds probably won’t “be materially worse than current market levels” in any restructuring. That’s good to know (figure below).

Smaller banks with exposure to Evergrande may be looking at a “significant” rise in NPLs, Fitch said Wednesday, but noted that the “overall impact on the banking sector [of a default] would be manageable.”

Fitch and Moody’s cut Evergrande earlier this month and S&P followed up Wednesday, downgrading Evergrande and its subsidiaries to CC (from CCC) and lowering the long-term issue rating on its dollar notes to C (from CCC-).

“The liquidity and funding access of Evergrande are shrinking severely, as demonstrated by an announced material drop in sales, a fall in the cash balance, and the continued use of physical properties to settle payments,” S&P said Wednesday, adding that,

Nonpayment risk is extremely high and could ultimately lead to debt restructuring. Signs of Evergrande’s deficient liquidity are worsening substantially. Given the company’s precarious financial situation, we believe financial institutions are increasingly unwilling to roll over loan maturities or grant new project loans. Evergrande’s very tight liquidity is manifested by its two subsidiaries’ failure to discharge their guarantee obligations, amounting to Chinese renminbi 934 million, on wealth management products for retail investors issued by third parties. Our view is that the subsidiaries’ failure to fulfill such guarantees does not directly constitute a default of Evergrande, given our understanding there are no guarantees between Evergrande and the subsidiaries in question. However, such a situation, along with the appointment of financial advisors to evaluate the company’s liquidity and explore solutions to ease the situation, leads us to believe that Evergrande’s default scenario, which could include debt restructuring, is a virtual certainty.

That’s pretty dire. Or, as I put it Tuesday, this soap opera is “rapidly approaching a rather unceremonious denouement.”

News of the forthcoming missed loan payments weighed on Hong Kong-listed Chinese shares, which fell 1.6%. Country Garden Holdings plunged (figure below).

Meanwhile, casino stocks are under pressure (to put it mildly) as Beijing moves to tighten regulations in Macau, which is still reeling from the impact of the pandemic. Gaming revenue was down more than 80% last month versus 2019.

“So, less gambling and more family entertainment,” Rabobank’s Michael Every joked, before asking, of Evergrande, “how long until the market takes the final hit and the firm is redirected to build social housing at low margins?”

And it just goes on. And on. And on. The Hang Seng Tech Index dropped another 3% Wednesday, for example. August’s poor retail sales figures were partially blamed, but it probably didn’t help that Xinhua said Beijing is set to speed the process of crafting and implementing laws aimed at preventing online crime, managing information and protecting minors on the internet. Xi will establish a nationwide platform to combat internet “rumors” and eliminate “fake news.”