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Thursday, March 28, 2024

The Evergrande Fiasco in Perspective

 

The Evergrande Fiasco in Perspective

Courtesy of Tobin Smith, Transformity Investing Newsletter

[From Transformity Newletter, September 21How We Make Great Profits From This Correction]

After doing few biz TV and radio hits this morning and afternoon sharing the reality of the Evergrande fiasco, I want to make sure you don't get shaken by it. Evergrande is not going to trigger a worldwide Lehmanesque financial meltdown. It just isn't.

Since my first meeting with the egomaniacal founder/CEO of Evergrande Hui Ka Yan in Shenzhen, China in 2012, I've been watching this disaster build. His fortune now stands at $7.3 billion, down from a peak of $42 billion in 2017. And since Mr. Xi decided to show the Chinese $billionaire entrepreneurs who is really the boss in the China economy starting with Jack Ma last November, Chinese stocks have lost over $1.5 trillion in value. 

To gauge the breadth of concern of bank solvency and the risk of financial contagion–which is when financial insolvency metastasizes into negative event feedback loops where highly leveraged banks, insurance companies, and hedge funds all get margins calls, forcing them to "puke up" their riskiest assets to cover their losses–let's use HSBC, one of the largest banks out of Hong Kong (and large holder of Evergrande debt) and the price of their "credit default swaps" (CDS).

Think of CDS as a life insurance policy for bonds. Speculators or bondholders buy them as speculation of a negative financial event or as protection against a negative financial event.

When greater than 50, CDS prices say the risk of corporate insolvency or bond insolvency is 50/50. Currently, the HSBC bonds are not close to the danger line. At 36, they were up 16% yesterday but still significantly below the 50 danger zone. 

(Click here is the current CDS costs for HSBC.)

Comparing HSBC CDS prices today with Lehman Bros or AIG in July/August 2008–there's no comparison–they were pushing 90 even before the default in September. 

Why Evergrande Will NOT get $50 billion Bail Out from the CCP But Real Estate Will NOT ALLOWED to take down the Chinese Economy 

The Chinese Communist Party just bailed out a state-owned asset manager from bad bank debt, Huarong Asset Management Co. Ltd., in August for $55 billion because Huarong was an SOE (State Owned Enterprise) that by definition WAS TOO BIG TO FAIL. (For more, read Beijing Embraces ‘Moral Hazard’ – The Huarong Bailout Was The Right Move)

The crazy founder of Huarong Lai Xiaomin who was known as "The God of Wealth" was executed by the CCP this past January for his sins against the State, for "corruption" which is a fancy word for losing too much of the CCP's yuan.

In my many visits to China, I found that the CCP likes to help CEOs of private companies remember that no businessman or woman is above the Chinese Communist Party. They reinforce the concept with highly impressive and graphic regularity. 

The new rules of the last 11 months in China's capital markets tell us that publicly owned Evergrande will NOT be bailed out this coming Thursday when they default on $300 billion of debt with just a $4 billion market cap (oh, the moral hazard Gods must be smiling).

Evergrande WILL get chopped up and sold for $1 RMB to various private, healthy, and adequately capitalized real estate development and management players and the owners will gain great "face" with the CCP regulators (in China, building and maintaining face, aka prestige, is culturally EVERYTHING). 

THAT is the CCP Chinese way. 

$300 billion of Evergrande bondholders will get 75%-ish haircuts as the bond workout vigilantes swoop in and pick at the bloody carcass. We can also strongly infer that the 12 million Chinese urban class households who have 75% of their net worth in the homes/condos they own…and the 2 million Chinese who have place BIG 75%+ cash deposits on Evergrande real estate under development… will NOT be left twisting in the wind with their wealth eviscerated in a Chinese real estate bubble popping.

Why? Most Chinese have their wealth in real estate, not stocks. Chinese save 40% of what they earn every month (no social security system) and put their savings into "wealth products" (fixed-rate debt syndications) and real estate (and some stocks). 

Only about 15% of Chinese residential real estate has a mortgage. (OK you can stand up now after falling over.) 

What China can NOT withstand, after 20 years of non-stop real estate valuation gains, is a 20-30%+ real estate equity wipeout. The homeowners' savings rate would skyrocket even higher and crater both the regular economy and their massive real estate development economy.

We can infer this outcome for many reasons that Westerners who have not walked the streets of Shenzhen (or Beijing/Shanghai for that matter) cannot conceive. The commercial enterprise we call "real estate", even with the CCP attempts to cool it down, comprises about 27% of the ENTIRE Chinese GDP.

Real estate in China IS TBTF. 

It is impossible to imagine the scale and size of Shenzhen unless you have seen it with your own eyes. It is a city/region of nearly 20 million people living in the same square mile footprint of Los Angeles county with just 10 million residents.

The other 10 million people live on the 2nd to 60th floors of over 100,000 multi-story apartments and condominiums. 

Even in this area of Shenzhen where five apartment buildings collapsed and hundreds died, I took this picture of new apartment "homes" being built on the same land. They just built over the collapsed land.


Another hard-to-imagine aspect of the China real estate economy is that cities, regions, and or Ministry of Finance car prevent people from selling houses 20% or lower from their acquisition price (or in some regions 20% below currently appraised value). Really, they can legislate that you, the homeowner, can't sell your house 20-30% below a certain price. Welcome to China. 

Bottom line: I am always amused and amazed when financial reporters who have never actually BEEN in China beyond Shanghai report breathlessly about the impending crash of the Chinese economy. Look, they have their own sovereign currency. Their citizens save 30-40% of their take-home pay in Chinese banks, and then they buy tangible real estate. The banks may lose money, but it's China's money and they can print all they want! They don't normally sell C.D.s to foreigners, and if they do, the foreigners convert their dollars or Euros to RMB–which the Chinese Federal Reserve bank manipulates simply buy selling US dollars that come in from Walmart, Target, Nike and Apple etc. when they pay their bills to Chinese manufacturing companies.

Out of $300 billion of Evergrande debt, only $19 billion is denominated in $US dollars–and those will be the first bonds to get schmeissed (a term I learned from Jim Cramer selling tax shelters and bonds to his hedge fund!). 

So don't worry about a China financial implosion. Look up the terms "state-controlled economy" and "Confucianism" culture. China is a wee bit different than the good ol' USofA. 

 

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