Hello everyone; I hope you have all had a wonderful weekend and have found that the start of the week to be equally fantastic. And with the usual flourish, let’s get straight into this week’s News, Views and Truths.
Subscribers and regular viewers of our YouTube channel will be aware of the problems in China; you can catch up on the specific issues here.
Since then, a bigger problem has emerged, with some analysts quoting the problem could be China’s “Lehman moment”, a reference to the bankruptcy of Lehman Brothers as a result of the subprime mortgage crisis, which triggered the 2008 global financial crisis.
And it is all down to a company called Evergrande.
Evergrande is China’s second-largest property developer, measured by sales, and owns more than 1,300 real estate projects in over 280 cities in China. The firm says it has 200,000 employees but indirectly created more than 3.8m jobs every year, with the company being involved in nearly 2,800 projects across more than 310 cities in China.
However, the company is on the brink of collapse after struggling to finance its $300bn debt pile. It has already warned investors twice in the last two weeks that it could default on its debts. Furthermore, the company has announced that its property sales will likely continue to drop significantly in September after declining for months, resulting in an even more dire cashflow situation.
Naturally, banks have responded to this, declining to extend new loans and rating agencies have downgraded Evergrande, citing liquidity problems. And all of this can be relayed back to the Chinese government’s decision to reign in property developers’ monopolies and excesses.
This has had a direct knock-on effect in the Chinese property market, with August data suggesting that national home sales by value had fallen by 19.7% year-on-year.
And it’s not just Chinese property investors and homeowners that are feeling the hit. The sentiment is already spreading to Asian High Yield bonds, with yields spiking to an average of 13%; to put this into perspective, US High Yield bonds, as referenced by the ICE BofA US High Yield Bond index, offer a yield of 3.96%.
The question now is how will the Chinese authorities respond to the situation, one which it may not have directly created, but certainly has exacerbated.
There is no doubt that Evergrande is a hugely important and influential real estate developer and if it was allowed to fail, would create huge consequences throughout the region. However, the Chinese authorities are clearly focused on removing the excesses and influence within the sector and as such, will most likely restructure the company, allowing other smaller developers to take over uncompleted projects in exchange for a share of Evergrande’s significant land bank.
Furthermore, it is unlikely that the Chinese government will want to have a domestic real estate crash on its hands in the lead-up to the 2022 National Congress of the Chinese Communist Party, given its historical importance.
But, as ever, only the future will tell us whether or not Evergrande is too big to fail.
That’s it for another week; if you haven’t already seen our latest Investment Manager video, click to watch Osamu Yamagata discuss the opportunities with Emerging Markets and in particular, smaller companies within the region. And if you do, make sure you “like” and subscribe to the channel!
And as ever, a playlist. Have a great week and I will see you all in seven days, if not before.