Welcome back everyone.
Another quick video on the developing situation with the Evergrande bankruptcy where we will
discuss the almost four hundred lawsuits that have been launched to date.
Over the last few months, according to records from the Guangzhou Intermediary People's Court,
$13 billion dollars’ worth of lawsuits have been opened against Evergrande over nonpayment
of debts.
Now, Evergrande was declared to be in “restricted default” on December the 9th by Fitch Ratings.
But all of these 367 onshore lawsuits being handled by the Chinese Courts were submitted
before that date.
In fact these lawsuits began piling up towards the end of August right after the Chinese
central bank first publicly criticized Evergrande and its management over its debt crisis.
This graphic from the FT shows a breakdown of the lawsuits, and as you can see the earliest
lawsuits back in August came in from construction companies and home buyers, who saw the writing
on the wall and were nervous about being paid.
After that financial lenders began to dominate.
Now we are of course at a very early stage in any restructuring, we are talking here
about $13 billion dollars of lawsuits for a company that has liabilities of over 300
billion dollars.
like I said, all of these lawsuits were launched before the official default on December 9th.
In addition, we must keep in mind that Chinese bankruptcy law gives preference to secured
creditors like banks over unsecured lenders like bondholders, so the banks don’t really
need to jockey for position early on.
On top of that, the banks in China are majority owned by the Chinese government and might
have less to worry about than private creditors, they will be involved in the political negotiations
around repayment.
There is a lot of information though that we can extract from these lawsuits which show
us how Evergrande financed itself and how widespread their borrowing has been in China.
There are some eye opening revelations about how contagion could develop from this default.
Evergrande has of course issued offshore bonds totaling $19bn, and we have discussed that
debt quite a bit on this channel, and that debt has been the main focus of the international
press, but once again, 19 billion is a small portion of the overall debt, and it is trading
at around 20 cents on the dollar right now, meaning that offshore debt could possibly
be settled for around $4 billion dollars.
I have also pointed out in my prior pieces that these offshore bonds have no real legal
claim on onshore assets in China.
They are high yield bonds that are not structured the way we typically think of debt.
These international creditors will of course be competing against domestic creditors to
get paid by Evergrande.
Now, some of the interesting information that can be gleaned from these court records is
about the shadow lenders who lent money to Evergrande.
There are 19 of these lawsuits in the mix, and it would appear that as the three red
lines policy cut Evergrande off from borrowing a year and a half ago the company turned to
private loans from cash rich local businesses last April.
These are businesses like hotels, metal traders and pharmaceutical companies who lent to Evergrande
with annualized interest rates as high as 73 per cent.
We have to worry about how much of this type of debt exists, as defaults on these mostly
undisclosed loans will of course spread the pain much wider than might have initially
been expected.
This is one of the ways we might start to see contagion within the Chinese economy.
The Chinese property market as we have discussed in earlier videos has mostly seized up.
Buyers are obviously very nervous, particularly as in China, buyers usually pay for a home
in advance of it being built and are exposed to the credit risk of the property developer.
Evergrande has reported sales over the last quarter (the quarter ending on November 30th)
these sales come to $2.4 billion dollars, which is down 93% from the same period last
year.
The Chinese government are trying to keep the real estate market afloat.
While Government officials have warned state banks not to help overleveraged developers
like Evergrande, they are pushing them to lend to less indebted property groups to prevent
a complete collapse.
The property development sector is obviously very important to China where it makes up
around a third of the countries total economic output.
I mentioned in my last video that based on prior Chinese restructurings the Guangdong
government is likely to take over Evergrande and find state-owned developers to complete
the existing projects.
After that, original shareholders including Hui Ka Yan – Evergrande’s founder will
most likely be wiped out.
There are around 1.6 million uncompleted apartments that buyers have paid for and the Chinese
government is unlikely to prioritize financial lenders ahead of these people.
The court records show that state-owned construction groups are suing Evergrande for around 2.5bn
dollars.
This of course complicates any push to ensure that these projects are completed.
Most of these projects have been paid for in advance by homebuyers who often borrow
as much as 25 years of household income to pay for a home.
The state owned construction companies are supposed to complete construction and deliver
the buildings, but they don’t have access to the capital to pay for materials or labor.
One construction company is quoted in the press as saying “We can’t carry on with
construction when our workers haven’t been paid for months.”
There are many other problems too.
In China there is no property tax, and local governments fund themselves through selling
land leases to property developers.
Now that the big private property development companies are on the rocks, state owned developers
have been stepping in and bought three-quarters of the residential land sold at auctions in
22 big cities by value, according to public records.
They had previously purchased only around 45 per cent of land plots sold at auctions.
So, this is a big increase in their purchasing activity.
This spending could be seen as a means of funding local governments now that their typical
source of revenue has disappeared.
When you combine the ideas that state owned developers are trying to complete these buildings
without funding and that they are purchasing land in order to support local governments,
you can see that there are cash flow issues and how the stresses are growing in the Chinese
property sector.
In my last piece on Evergrande I suggested that the best way of predicting outcomes in
this situation is to look at the example of HNA group, the biggest bankruptcy that China
has seen since first introducing a bankruptcy law back in 2007.
In China, the courts and local authorities have a lot of leeway in deciding which creditors
get paid and when.
Historically, China’s supreme court has ruled that building subcontractors take priority
so that migrant workers, are guaranteed payment for their labor.
As I mentioned in that last Evergrande piece, less than 100 listed companies have ever gone
through bankruptcy proceedings in China, so we don’t have a lot of data.
Chinese bankruptcy law does give preference to secured creditors like banks over unsecured
lenders like bondholders, and in the mix of lawsuits, over forty are from banks, but this
is obviously just the tip of the iceberg.
These lawsuits all come from before Evergrande’s official default and analysts are saying that
Chinese banks are reluctant to announce their exposure to Evergrande by taking court action,
and will be working in the background dealing with politicians to work out their claims.
We are likely to see a prolonged battle as Evergrande is wound up.
Chinese authorities have been clear that social stability is of the greatest importance, and
so home buyers, suppliers and contractors who are still awaiting payment from Evergrande
are likely to be prioritized.
If you liked this video, you should watch this one next.
Have a great day and see you soon, bye.