Thread by @travislundyasia

A short follow-up on Evergrande ($3333 HK)

Thanks to all for listening to the podcast with @TheStalwart and @tracyalloway.

First, some housekeeping:

The podcast is here (or on Apple podcasts, or Spotify): bloomberg.com/news/articles/…

The transcript here: bloomberg.com/news/articles/…

Since we recorded that, there have been any number of news stories and developments covered in the SCMP, the FT, WSJ, NYT, and more. They have been informed and relevant.

There have been a few threads by @michaelxpettis and commentary by @niubi well worth reading.

There has been recent news which deserves a bit more nuanced treatment because it looks, as of today, we may be getting a resolution sooner rather than later, which is only a little surprising.

Development #1: Sep contract sales have, it appears, fallen through the floor.

Development #2: Interest payments due to banks on 20 Sep were apparently not made. An "agreement" was reached with bondholders on an onshore yuan bond issued by a sub, which suggests private accommodation to delay payment w/o getting it labelled a default.

The NEXT development will come with a USD OFFSHORE (8.25% Mar22) bond coupon ($83.5mm) due on 23 Sep. IF they pay it, there is another coming 29 Sep. If they DON'T pay it, then there is supposed to be a 30-day grace period. Strategically, it isn't clear offshore bondholders would

want to trigger that immediately.

There are, however stories out there now about how foreign bondholders are going to get treated badly at the expense of individuals and suppliers.

That deserves some attention.

A very simple version of the basic capital structure of Evergrande looks like this.

The Evergrande foreign investors look at is the dark blue entity. The equity and bonds they buy/own are issued by the blue box.

Evergrande owns stakes in the cos stacked at left, and it owns a

63.5% stake in the red box (Hengda) which is the parent company for its real estate development business onshore.

Hengda has a whole bunch of subsidiaries (shell cos and opcos and holdcos, and then underneath them, individual project companies). Several hundreds of them.

The below is a Simplified Corporate Structure showing only the cross-guarantors (in gray) and the issuers (in white). Evergrande is the blue box at top. Hengda is the red box at left.

When a project is built, it usually sits in one of those tiny boxes at bottom, or even hanging off one of those companies at the bottom, it will have land, customers, bank loans against the project, cash in escrow accts, etc. And there are hundreds upon hundreds of these boxes.

The parent company may interact with each consolidated subsidiary slightly differently. Lending or owning equity. I expect the accounting is highly 'optimized', and bank lending is probably secured and cross-secured.

When suppliers don't get paid, they don't get paid by

one of those tiny white boxes, or a box hanging off the bottom in the non-simplified structure (which must be horrendous). Those who plunked down their deposit or a mortgage to buy a property did so at that level or possibly one above, but NOT at the level of the red box.

The red box owns all the eventual equity - the future profits - of those little white boxes. And it has issued debt. The debt for trust loans may be lower down, and then cross-guaranteed, but basically none of it comes up the chain to the blue box which is Evergrande.

Evergrande owns 63.5% of the shares of the red box. The business of Evergrande in real estate is inside the red box and its subs. If Hengda Real Estate needs to be restructured (it does) and a creditor committee starts running it, the creditor committee probably involves the

largest SOE banks, but most certainly some regional banks too. If they decide to take it over, then one can be pretty sure the equity of the RED box is deemed to be effectively zero (though something might come out of it).

But that doesn't necessarily mean the BLUE box

dies on Day 1. That depends on what the bondholders at top right do.

Those are the foreign bondholders who some are saying will get the short end of the stick.

Importantly, they are creditors of the blue box. NOT creditors of the real estate business (red box).

They have access to the residual equity in the red box, but it isn't theirs to work it out if creditors take over the business.

There is no indication yet "foreign bondholders will be mistreated."

(Structurally, they may have mistreated themselves).

They own access to enormously illiquid residual value where other lenders have seniority. That's it.

There are some indications in the last 24h that the organisational groups working behind the scenes for the past couple of months have started putting the tiles on the table.

Remember, months ago, the PBOC said to EG they should not "cause systemic disruption." That means "don't offer property too cheaply." An SCMP article this AM showed some cities are asking developers to stop throwing themselves into death spiral.

scmp.com/business/china…

The banks were unofficially told by the MOHURD early last week they wouldn't get their interest on the 20th. They organised themselves to not get it that day or in the 1-day grace period, and the bondholders of the bond which saw "private agreement" (i.e. not thru the clearer)

also managed to agree not to call a default. The FT article mid-day HKT shows that banks are clearly running the show now.

A number of them (Bk of Zhengzhou, Zheshang Bk, Changshu Bk, Industrial Bank, Jiangsu, Jiangyin, Wuxi, Qingnong) all came out

ft.com/content/a29e6b…

today saying their exposure was manageable, with good collateral, and they were closely monitoring the situation, or they had no risk to EG. That so many came out tells you the situation is top of mind, for both banks and regulators.

The magic words "guarantee the delivery"

showed up a few times in the last 2 days. Banks mentioned they are working with local govts to "guarantee the delivery" [of homes to buyers], and Chairman Hui's letter to employees notes that is the primary goal.

This goes hand in hand with the priorities noted on the podcast.

There have been some "Chinese government sources" articles today suggesting a state-sponsored resolution in line with what some senior Evergrande execs had called a "last resort" might actually be forthcoming in the very near future.

The model would be that Evergrande RE (Hengda) would be split into a few regional entities, and SOE banks and SOE companies would sponsor rehabilitation/support with the goal being to "guarantee delivery" and pay back WMPs.

Personally, I expect that if the govt pays out the WMPs in full without forcing a haircut of either principal, coupon, or time, that would be a shame. Even small savers have to be made aware that funds yielding 10% (when govt bond funds yield <4%) are not risk-free.

The other points which tell me that a solution is nearer rather than further are



1) a Caixin article today which talks very specifically about how Chairman Hui enriched himself and his friends in Evergrande Auto without selling a single car.


caixinglobal.com/2021-09-21/in-…

2) articles in sina saying Chairman Hui had taken many billions of $ out of Evergrande even though the company was doing badly.



These two articles are setting the stage for people to not have any sympathy for him.

He hasn't been thrown completely under the bus, but...

3) An article in the Economic Daily - an official Chinese govt outlet - this morning titled "Real Estate Companies at the Crossroads" (房企行至十字路口).

The highlighted portion is key.

xinhuanet.com/house/20210922…

An official outlet telling us that the Real Estate Industry's stable and healthy development is vital to the entire economy and society.

And after dealing with over-leverage, a new model is ahead.

This tells me "those which have to go have to go, others will figure it out."

And the executives who put money into R&F and sold a sub in order to shore up capital are obviously Doing The Right Thing. And I expect they will be given some leeway and good press.

The question has been where the pain point lies for the government and it is possible that

getting some clarity on banks (which fell today on the first trading day after the Mid-Autumn Festival holidays) and ongoing creditworthiness/support is worthwhile ahead of the Golden Week holiday coming up in a bit over a week's time.