Roughly two weeks after we covered it, the potential collapse of a major Chinese corporation now threatens to unravel the bull market. Evergrande, China’s second-largest real estate developer, was well on the path to insolvency earlier this year.
The company was also China’s largest issuer of commercial paper, or very short-term corporate bonds. Evergrande earned this title after the Chinese government banned it from issuing longer-term debt. So, in order to raise capital, Evergrande turned to short-term debt (commercial paper). That normally wouldn’t be an issue, but in this case, Evergrande was rotten to the core. Its revenues were tanking as billions in bonds came due.
Large creditors, aware of the deteriorating situation, pooled their resources and took Evergrande to court in an attempt to get at least some return on their investment. That was in August.
Fast forward to last week, and Chinese retail investors joined in on the fun. They camped out at Evergrande headquarters, holding executives hostage in their offices while demanding payment. Thousands of Chinese – many of whom had little bond-buying experience – put their life’s savings into Evergrande commercial paper, which promised a 10%+ return.
Now, they stand to lose everything as Evergrande (and its junk commercial paper) crumbles. The Chinese government could still step in to bail out Evergrande, of course. That has yet to happen, however, and investors have taken matters into their own hands in the meantime.
But it’s not just Evergrande bondholders that stand to get burned. To pay creditors, the company will have to liquidate its $355 billion in assets to cover roughly $305 billion in liabilities. And though assets exceed liabilities, the truth is that Evergrande won’t get anything near face value for them.
The company just sold its headquarters at a steep loss. A fire sale of Evergrande’s real estate holdings, which make up a large portion of China’s total real estate market, would devalue properties almost instantaneously. Banks would get whacked, too, as mortgages get caught in the ensuing crossfire. Bond issuers are already withholding new offerings in anticipation of more Evergrande drama.
In short, Evergrande won’t be able to pay creditors even if it liquidates, as its assets aren’t really that liquid. Several weeks ago, we said that China would either bail out Evergrande (the more likely option) or let it go belly-up. Going bankrupt would undeniably cause more damage. Eight investment-grade debt issuers just pulled their bond offerings this morning in fear of having them priced unfavorably. Evergrande’s “contagion” risk via bankruptcy is already showing.
A bailout, by comparison, only threatens to devalue the yuan and (temporarily) most other assets as China is forced to buy roughly 300 billion US dollars to pay creditors, which would cause the dollar to rally sharply.
A bailout would also make Evergrande a business partner of Beijing – something that falls right in line with the Chinese government’s long-term plans.
Today, it seemed that investors finally realized how dangerous a looming Evergrande bankruptcy truly is. US stocks opened trading this morning for major losses that only grew worse around noon.
But is this the start of another Covid-like equity crash? Probably not. China is likely to issue some sort of statement or response within the next 24 hours. Odds are, it will include bailout terminology.
Add to that a coming “no taper” decision from the Fed when the September FOMC meeting wraps up on Wednesday, and you’ve got the makings of another whipsaw market rally.
Potentially as soon as Thursday or Friday of this week, and maybe even close to the S&P’s recent highs.
