Bone Picking
*Evergrande is seeking another bond payment delay; *Chinese municipalities are getting into the act with repossessions and demolitions; and *Without collateral, banks are now on the hook.
China Evergrande Group (3333.HK) [“Evergrande”] is getting hit from all sides. In addition to Evergrande now seeking a six-month delay in the redemption of and coupon payments on a CNY 4.5 bn (USD 157 mn) bond with bond holders this weekend, due to the "current operational status" of its property developer, Hengda, mainland Chinese municipalities are also getting into the act.
Under mainland China’s real estate development law, the central and local governments have the right to repossess land sold to any developer that has been sitting idle for two years — without compensation to the property developer. The thought is that the lack of use is “objectively detrimental to local development”. Two cities have stepped in and repossessed land from Evergrande. The City of Chengdu has taken two plots of idle land from Evergrande, following the same move by the City of Haikou. In the case of Chengdu, these two repossessed land plots were sitting idle since 2010 and 2011. Haikou repossessed eight plots of land over Evergrande’s failure to develop, although no details appear to be available. Given the how poor Evergrande’s financials were for that period, it’s a bit surprising that the land repossession trigger was pulled as late as it was. Nonetheless, we expect other local governments to follow Chengdu and Haikou.
Despite its financial condition, during 1H21, Evergrande continued to acquire 15 plots of land, as well as land surrounding 14 of its existing projects. At 1H21, Evergrande had 778 land plots across 233 cities in mainland China, with a planned GFA of 214 mn sqm with an original value of CNY 456.8 bn (USD 71.7 bn). While we do not have the dates of actual land acquisition to determine lender value at risk, assuming an even purchase of land plots since 2010 (could go back further), this would suggest that upwards of CNY 374 bn (USD 59 bn) in stated land bank value could be at risk – land bank to which local banks directly lent to. Without any compensation, mainland China banks no doubt will finally have their hands forced in writing down their exposure to Evergrande and other developers with idle land plots for two years.
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To make matters worse, on December 30, 2021, Evergrande received an order from Danzhou City authorities in Hainan to demolish 39 buildings on the man-made Ocean Flower Island, a large integrated resort development where Evergrande has spent CNY 81 bn (USD 13 bn) to build 60,000 homes. According to local media, the demolition needs to be complete within 10 days due to Evergrande’s illegal construction and environmental violations. Somehow Danzhou City only figured out these violations as Evergrande struggles to find liquidity. Nonetheless, mainland Chinese municipalities should continue to find numerous ways to bone pick Evergrande’s carcass – leaving Evergrande’s lenders and bondholders with even less to work with.
As discussed in our “Not Grand At All” note dated December 23, 2021, numerous mainland Chinese banks remain vulnerable to Evergrande’s dilemma – none more so than Shenjing Bank (2066.HK) [Shenjing]. If Shenjing's CNY 129.4 bn exposure to Evergrande is even remotely correct, it would appear that Shenjing has materially under-reported NPLs. Nevertheless, if we include the Evergrande exposure in totality, we find that stated NPLs to total loans would rise to a whopping 24.4%. Provided that Shenjing gets to 100% reserve cover of adjusted NPLs (only for Evergrande and not for any other troubled exposure), a reserve shortfall of CNY 128.4 (USD 19.9 bn) would appear to exist – representing 158% of 2Q21 stated equity. In other words, Shenjing appears to be technically insolvent, in our view, as well. Evergrande has already been in contact with its lenders to request loan maturity extensions, including: China Minsheng Bank (1988.HK), China Zheshang Bank (2016.HK), Shanghai Pudong Development Bank (600000.CH), and Citic Trust (267.HK).