Thread by @LastBearStandng

BIG PICTURE China Credit Update (8/30/21)👇👇

Since initially warning about China's credit markets in June (an eternity in Twitter years), a lot has developed and so its worth zooming all the way out and re-evaluating the thesis:

2/ Recap: I argued that China's credit markets posed underappreciated risk as a massive growth in debt since the GFC was put strain on the banking system, and that the property sector was the key risk given its size, role in economic growth, and private wealth held in property

3/ This setup is not new, but Beijing's recent push to break moral hazard is. Faith in central invention has been the key to maintaining peaceful markets and therefore the push to break the backstop introduced a critical new risk that could make this episode unlike previous ones

4/ While SOE and private defaults have increased dramatically over the past year, specific stress in Huarong (largest bad-debt bank) and Evergrande (most indebted developer) highlighted the degree of stress, and given their size could each be catalysts for contagion

5/ I drew parallels to US housing bubble - namely that debt a fueled property bubble topping combined with tightening monetary policy led to bad debt materializing. Financials with large exposures eventually failed, triggered further disruption and spawning a financial crisis.

6/ So as of 8/30 does this thesis still hold? Yes, in fact all the signs are that it is playing out right now.

7/ First - stepping back, Huarong initially failed to report its 2020 results at the end of March. Huarong received state backed liquidity through the end of August, when it had promised to provide its annual report.

8/ On Aug 17, Huarong announced a deal for $7.7bn of strategic investment which sent bond prices soaring and seemed to give the "all clear" signal that state support remained strong, sending bonds soaring with spillover benefits for other stressed issuers

9/ Today, with one day left before its August deadline, Huarong filings confirm that it had taken losses of $16 billion in 2020, more than double the strategic investment amount, and that its capital ratios remained about half of the regulated minimums

10/ Rather than an "all clear" I would argue that if it takes 4 months to find under $8bn of capital to support a majority state owned bank, which still seems insufficient relative to its losses, this is a bad signal for the ability of central intervention to backstop ailing firm

11/ On Evergrande, their situation has rapidly deteriorated, with a very near term restructuring likely. Offshore bonds fell from 80 to 36, stock fell from $12 to $4, chairman was removed, creditor claims are being centralized and credit committee appears to be forming. Bad.

12/ But notably, EG onshore debt jumped with the Huarong strategic investment announcement on the 17th. There is now a massive divergence between offshore and onshore. However volumes remain tiny relative to the volumes when the bonds were falling.

13/ In any case, this episode does indicate just how important the indication of central support is, which continues to be the most powerful tool to avoid a crisis - and could end up proving to be successful.

13/ Yet, any this implicit support is counteracted by Beijing's increasingly forceful actions to curb property which has *top-line* impact to developers, and the crackdown on shadow banking financing sources will choke out critical lending channels creating more financial stress

14/ Net net, I contend that these negative regulatory actions are having a far bigger impact on the property sector than potential positive read-through of potential state support based on Huarong

15/ EG and Huarong are merely the highest profile tip of the iceberg, not outliers. And handling "just the tip" has been met with months of confusion and uncertainty, my confidence in authorities averting a broader credit crisis if it appears is not very high.

16/ Today we also learned that Ping An, the largest insurer in China took significant losses relating just to a single developer, China Fortune, and regulators were probing the company's property exposure. The parallels are obvious, and highlight the risk if other credits fail

17/ Away from these two specific credits, the Chinese economy has been deteriorating since the post-lockdown rebound, with consumer demand very weak and notable absence of demand for credit by businesses (noted by @ChinaBeigeBook)

18/ Chinese equity indices are now down 20 - 25% since their peak in February - with a majority of the drawdown occurring before the specific tech crackdowns that have crushed individual names and caught the attention of Western ADR holders (HSI & CN50 below)

19/ Taken in whole, I continue to be highly wary of the conditions in China and believe that risk is grossly mispriced. China has provided a huge portion of global economic growth over the past decade and a recession there would have massive global ramifications

20/ Now - that is clearly not a certainty. Smart people can debate the lowlihood, but it is meaningful enough that it must be a consideration in your outlook. To those who have followed this saga and asked when or how US equities could be impacted here is my answer:

21/ US Equities remain levitating, ignoring all warnings of weakening growth globally and domestically. The key factor keeping markets pinned at ATHs is the enormous buildup of options interest - and dealer hedging thereof.

22/ As explained in further detail below, the market is being pinned at its leveled by massive buildup of near-the-money calls, but open-interest is historically skewed to the downside, paving the way for the a reinforcing violent drawdown if vol spikes

https://twitter.com/TheLastBearSta1/status/1424833306781159433?s=20

23/ The key way a China meltdown could spill over is by providing the exogenous shock that triggers a massive short-vol unwind. But it is just one of many potential catalysts.

24/ The future is unknowable, and the timeline is even harder to predict. Its possible this crisis happens in weeks, takes years, or never develops at all. The purpose of this thread is merely to share my analysis to those who are interested. As always: share your thoughts below!

Also, I recommend the following accounts if interested on this topic:
@sunchartist @ImJames_K @Sino_Market @ChinaBeigeBook @ChinaPropFocus @anderpart

Original thread:

https://twitter.com/TheLastBearSta1/status/1399748954082971659?s=20

Ping An (2318.HK) down nearly 8% by noon in Hong Kong