In mid-August, Dominic Pino noted, “China’s largest property developer, bucolically named Country Garden, is on the brink of default. Its bonds are currently trading at less than 10 percent of their face value.”
A few days later, I added more on Country Garden’s plight in a Capital Letter, including quoting from an article in the Economist, including this:
Country Garden is renowned for its huge projects in China’s second- and third-tier cities. The firm’s debts are smaller than those of Evergrande, a big, heavily indebted company that defaulted in 2021. But at the start of the year Country Garden was building four times more homes than Evergrande was before it defaulted. At the rate Country Garden was delivering them in the first half of 2022, at least 144,000 buyers will not receive homes they were promised by the end of this year. A sudden debt meltdown at the firm would leave even more families out in the cold.
Until recently, most thought that Country Garden was immune to default. Since late last year officials have sought to calm the market by drawing up an informal list of healthy developers, including Country Garden, which investors could feel comfortable funding and Chinese citizens could trust.
The calculation has changed in recent days. Country Garden’s issue is not one of over-leverage in the style of Evergrande. Instead, it is a victim of a loss of confidence among regular folk—a sign the government is losing control. After a short rebound following the lifting of covid-19 controls, the property crisis has intensified. Prices are dropping.
It now seems that Country Garden is toppling over the cliff.
The Wall Street Journal (October 10):
Chinese property giant Country Garden failed to make an international debt payment after its apartment sales plunged in September, succumbing to a liquidity crisis that worsened over the past few months.
The 31-year-old developer said it wasn’t able to repay a $60 million loan denominated in Hong Kong dollars that was due. Country Garden said it also doesn’t expect to meet all its U.S. dollar bond and other offshore debt obligations when they come due, or within grace periods—effectively saying that it expects to default. The company has hired financial advisers and plans to hold talks with its offshore creditors.
Country Garden said its sales have come under “remarkable pressure,” which worsened its problems. The developer’s contracted sales in the first three quarters of this year dropped 44% from a year earlier to the equivalent of about $21 billion. The drop was particularly steep in September, when Country Garden’s sales plummeted 81% to just $846 million, it said in a regulatory filing.
Put another way (a short bump aside), there is no sign of any return on confidence despite the measures taken to coax buyers into the market.
Not so long ago, Country Garden was regarded as a role model. Banks have showered it with loans; the company even raised new equity last year (the shares are now penny stocks).
One major concern will be the plight of those who have, in whole or in part, pre-paid for their homes — something that has been an issue with other troubled Chinese property companies. Country Garden has said that this will be a priority, and it’s not unreasonable to think that the Beijing regime, aware of the dangers of instability, will insist that this be the case.
Meanwhile, the news is not getting better for Evergrande, China’s second-largest property developer, which filed for Chapter 15 bankruptcy in New York during the summer in order to help its restructuring.
The Wall Street Journal:
Evergrande has yet to deliver hundreds of thousands of apartments that it presold to Chinese citizens, and its chairman is being investigated for potential crimes.
On Monday, some of Evergrande’s international creditors expressed dismay at the recent cancellation of the developer’s $35 billion offshore debt-restructuring deal, and warned that it could lead to an “uncontrollable collapse” of the group and potentially catastrophic effects.
So, to revive a fashionable word from the eurozone and great financial crises, what’s the risk of contagion?
The Wall Street Journal (October 2):
Property is the heart of China’s economy, driving around a quarter of total economic activity.
But both banks and China’s “shadow banks” like trust firms have rapidly shed property exposure in recent years. Total loans to property developers and home buyers peaked at nearly 30% of commercial banks’ loan books in 2019, according to central bank data. That had fallen to just 23% by mid-2023.
Moreover, the biggest chunk—individual home mortgages—is probably relatively safe due to the way they are structured in China. Down payments are large and loans tend to be recourse, meaning banks can go after other assets besides the house if homeowners walk away.
Unfortunately, banks’ seemingly manageable direct exposure to property is deceptive because of the housing market’s deep links to two other key borrowers: Heavy industry and local governments.
Heavy industries such as steel feed directly off construction, while local governments, especially in smaller cities, finance themselves with land sales to developers.
Chinese heavy industry is, however, the WSJ notes, in better financial shape than a few years back, but local government finances are (as noted in that Capital Letter — and the WSJ has more details) are in a mess not made easier by its complexity, and not helped by potential home buyers going on strike (land sales are an important source of revenue for local governments). Obviously, that raises more question marks about the banks. The WSJ is fairly sanguine about the financial condition of China’s larger banks, but it’s worth noting that when the dominos start tumbling, seemingly well-capitalized banks have a way of turning out to be a lot less robust than thought. As for China’s smaller banks, particularly in rural areas, well, let’s just say that they have been recapitalizing, although whether that will provide enough of a cushion must be questionable.
Overall, Nathaniel Taplin, the author of the Journal’s piece, thinks that one way or another, China “may well” avoid a “systemic financial crackup in 2023 and early 2024”. Maybe. An authoritarian state is better placed to “encourage” financial players to do their part to keep the situation under control. China’s economy is heavily distorted by the actions of an activist state. It shouldn’t be impossible (for now) to distort that economy still further in the interests of stability.
We’ll see. Taplin concludes:
[China] is unlikely to avoid serious damage to banks’ balance sheets — even at healthier lenders. That will have its own costs: less cash available to support small businesses and grandiose industrial policy, and ultimately, probably slower growth.
I might delete that “probably”.
Meanwhile, with the eurozone also looking increasingly shaky, the outlook for global growth next year isn’t looking too good.