Thread by @bauhiniacapital

It still makes the news and I was asked to do an Evergrande thread, so here it is.

There were headlines/noise again this week in China property space.

Backdrop is important. The Three Red Lines policy put in place in late Aug-20 was designed to make the heavily indebted (1/n)

sell assets, or sell equity. There was no alternative. None.

Some commentators suggested "neither analysts nor media saw this coming" but it was not new. In 2019, Evergrande interest and payables funding than > NP. And it increased net accounts

asia.nikkei.com/Business/Marke… (2/n)

receivable by 4x NP (8x if back out minority interest). And when you pay ~10% on an increasing debt pile (at 175+% of sales), the INCREASE in funding cost on payables is a large chunk of NP, and if NPM can't clear 5%, and you can't take on more debt (3RL), that's trouble. (3/n)

UBS wrote a big report on developers fudging debt numbers. 3RL caused more fudging but regulators caught on. It'e been fashionable to call "Evergrande contagion" but the PBOC knocked EG in 2018, not 2020, and EG+11 in 3RL in Aug2020. Some acted quickly (Sunac+); some did (4/n)

not. Few tycoons wanted to dilute themselves or go into run-off mode. Mistake.

3RL was a top-down policy decision to stomp on RE speculation. One might liken it to a decision to try for herd immunity.

The Odd Lots episode w/ @michaelxpettis in early Oct was excellent. (5/n)

He talked about the "good growth vs bad growth" dichotomy. It had to be fixed. Wait longer, it hurts more. There is no easy way out of it.

Regulators had knocked down HNA, Anbang, Tomorrow Group, Baoshang Bank, CEFC, and there were other large (6/n)

https://twitter.com/tracyalloway/status/1447476656214462465?s=20

financial sector entities (EG since 2018) in their sights, and they were not going to stop going after them in XJP's second term as he approached a 3rd.

The obvious interlinkages: There were no non-SOEs too big to fail, and the culture of 'Shenzhen Speed' (whether in (7/n)

propertyworld or VC world) would suffer. Indeed, it did. The 3RL forced analysts+journos to catch on to property quickly. Internet names were later (Ant Financial, then more). Debt was still a viable market and analysts went quiet. The QT chart here (8/n)

https://twitter.com/bauhiniacapital/status/1439220735508054021?s=20

(whole thread may be informative for some) shows lots were in not great shape. EG, Greenland, Central China, China Fortune, Sinic, Sunac, Kaisa, SZ Languang. Some defaulted early 2020. EG took longer but was inevitable. They had CAB problems in 2020 if not 2019 and were (9/n)

scrambling in Q3-Q4 2020, more so in Q1-Q2 2021. Critical blog posts and news articles showed up in the mainland in Q3-Q4 2020, and more explicitly in Q1 2021. Regulatory cover crumbled in 2020, became hard early 2021. Since then, for outside observers and market players (10/n)

it has been a question of not if but how bad. Even now, I can only guess.

By Q4 2020, overseas funding for the sector was dead until catharsis had been achieved. It was just a waiting game. By July 2021, all the pieces were in place. The PBOC had (11/n)

https://twitter.com/bauhiniacapital/status/1439467257302695936?s=20

been "checking" new loans since Aug-20. And had already gone to every bank in Q1 2021, and started investigating EG's 'house bank' (2066 HK), in Q2 required monthly reporting of increases in CABs, and by end-Jun21, the Financial Stability Commission - the highest financial (12/n)

authority in the land - had called Chairman Hui on the carpet when he was in Beijing and said, in effect, "You're big. It's bad. Sell assets. Sell equity. Don't slash prices causing industry-wide problems."

Offshore bonds had already crashed. Onshore bonds were dodgy. (13/n)

Lawsuits were starting to line up. In early summer, the State Council put it on the Guangzhou govt to sort it out. Like previous processes. And the ENTIRE time, there was the steady PBOC drumbeat that they would not pump up the economy via the property mkt. In late July/ (14/n)

early Aug 2021, EG brought in DD teams, HL for restructuring, the govt was in unofficially, EG missed loan trust+WMP redemptions and bank loan interest, and couldn't sell its HQ. That was it. EG's make-or-break Sep-Oct sales season was over before it started.

The big Q?
(15/n)

How would all this play out?

The efforts to sell 6666 HK, the GZ and HK HQ buildings, Hengten, etc starting in June and culminating in Sep were instructive. EG was on its own. No state bailout. Local govt/SASAC entities couldn't do anything. Pay too much, bad. Pay too (16/n)

little? Maybe fraudulent conveyance. Therefore SOEs could only bid super-low and EG couldn't do that.

A RTRS story in Sep said Beijing wanted SOE builders to buy EG projects. That story had been out in June-July. But once the DD/restructuring (17/n)

reuters.com/world/china/ch…

people went in, we were set for a year of unknown. EG would do DD, but SOEs couldn't trust it. And as with each of the previous "govt admin" efforts when BK loomed (HNA, Baoshang, CEFC, Anbang, etc), nobody can really do anything until the local govt goes in and checks (18/n)

EVERYTHING. For Evergrande (3333 HK), that was the 1st wknd of Dec21. The local govt 'Work Group' was officially in days later. 6Dec was the EoD on the Notes (all comments about missing coupons since then are just noise). There will be more noise as more lawsuits pile up. (19/n)

More lawsuits, news about LGs taking back land + projects, requiring teardowns are all about putting timestamps out, and getting what one can b4 the Big Official Report comes down many months from now detailing the wrongdoing. That report will be an absolute doozy. (20/n)

There will be perp walks. There will be news and noise between now and then, but there will be no "final clarity" until the Big Official Report comes out.

There are 800+ projects across 200+ cities. Some "better" (i.e. first homes) some "worse" (speculative 2nd homes) (21/n)

The govt may want to differentiate btwn who takes the hit, but w/i a project, that doesn't work. It will take months before the Work Group is done sorting through the project numbers and layers which matter. The PBOC has clearly instructed banks (22/n)

https://twitter.com/bauhiniacapital/status/1471400080137932800?s=20

NOT to NOT LEND. And back in November, SOEs asked regulators to exclude M&A-borrowing to help buy projects from defaulted developers from 3RL requirements. But the State Council is obviously not letting local govts break out the party favours (23/n).

reuters.com/business/chine…

And while there was new news of M&A loans in late December, there are still issues of seniority and projects, and only when projects are static-in-the-black will they be "easy" to sell. (24/n)

scmp.com/business/china…

In the meantime, asset buyers and local govts will probably abide by a priority list.

1) Homebuyers who have paid
2) Unpaid Suppliers/contractors
3) contractors going forward
4) Local govt taxes
5) Project-secured lending
6) WMP investors
7) Unsecured Hengda lenders
(25/n)

8) Hengda equity = 3333 bondholders
9) 3333 equity holders

The cleanup will then be driven by an understanding of how much the creditors of each project are owed, and it will be messy because after The Big Report, local govts will be putting forth their own interests. (26/n)

Three Odd Lots Podcasts on Evergrande (in calendar order) were:

1) @travislundyasia in

https://twitter.com/TheStalwart/status/1439906034743750660?s=20

2) @IsabellaMWeber in

https://twitter.com/tracyalloway/status/1443494537133842432?s=20

3) @michaelxpettis in

https://twitter.com/tracyalloway/status/1447476656214462465?s=20

Each was a bit different. Each probably worthwhile.

@michaelxpettis had a worthwhile big picture piece in late August on the economic "bezzle" of the space.

https://twitter.com/michaelxpettis/status/1429784329962639369?s=20

And @georgemagnus1 wrote a piece in the Guardian in late October which points does not disagree with any of them and is also worth reading.

https://twitter.com/georgemagnus1/status/1449071588578582535?s=20

And as backdrop I would always point to the input of @danwwang's excellent appearances on Odd Lots (including one in early Sep) and his #mustread end of year note to help with the ever-evolving zeitgeist.

danwang.co/2021-letter/

And after an overly-long and pedantic thread, I look to the following major points:

1) the BIG picture in China real estate is trying to figure out the forward point to which Beijing is aiming. I don't know yet. "Good GDP" vs "Bad GDP" is one thing, but the animal spirits of

China household savings are driven by a lack of social safety net, so housing has been an inflation-hedged, income-producing asset to provide for one's end-of-life. Make that a real problem for tens or hundreds of millions and that creates mass problems. I think Beijing stops

squeezing before that, but it creates
2) as each Odd Lots guest pointed out, "it's all connected". Property drives the economy. It is inefficient but inefficiency distributes income. Unfortunately, the existing model put more money into the hands of capital providers than

"desirable." That is changing fast.
3) Housing markets go up and go down, speculation comes and goes, speculators win and lose. But the Budget Law of 1994-5 which pushed control of local financing to local govts and Land Reform shortly after meant local govts funded themselves

with land sales. Developers started with nothing, and last year had 3-4 years worth of debt-funded land bank. If the debt becomes impossible to roll, then developers run down land bank. They don't buy new land.

ft.com/content/13476b…

Local govts don't sell land. Local govt funding drops sharply. And new property tax measures, which were always going to be unpopular, are getting pushed back.

The flow model is now broken. Beijing needs a new one.

4) I personally expect the desired model is to have local

governments sponsor low-income housing, through Let-to-Own schemes, combined ownership, etc. There are pilot programs under way. This would allow the land bank to be sold, but funded at CGBs+50, not CGBs+700.

The problem: the plan wasn't in place, ready for rollout.

5) The government appears not to have planned for the displacement of wealth effect. In H2 2014 there was a clear push to get people to buy stocks and in late 2014-early 2015 there was a property dip. This time there is no easy mitigant. The govt has signalled lower GDP for years

based on a quality-vs-quantity ideal. The question is how to put that into effect in a "market economy" which is how most people get paid, rent a place, consume, etc.

Taking out debt growth eases forward debt-fuelled savings growth, but it puts the entire householder base on

their back foot. Not everyone wants to sell. Lots of people own their property to live in it. But a LOT of property sold in the last 10 years is 2nd homes for rent, assets held in relatives' names, and lots and lots of people do NOT want to see a property tax mean name give-up.

Theoretically, this means the primary market will weaken, the secondary market will see substantially increased turnover at lower prices, and incremental savings will go elsewhere. Where? Who knows. But wealth effect will shrink some.

As to critique this is backward-looking...

It's a backdrop. I said a couple of times already here I don't know the whole policy goal. I've said that for months but even local govts find it hard now. I don't have an inside track, I can talk about precedent and path.

I've been (forward-looking) bearish the stock/bonds for months/years. I think the stock is a zero. Bonds I don't know. I was bearish 95 a year ago. I was more bullish 25-30 in late Q3 than I am now at <20cts (I thought the LG further along, and the EG pocket lint worth more).

I think the securities have been uninvestible since Sep-ish. Too susceptible to policy innuendo. Others are braver than me.

The longer this takes, the less the onshore unsecured is worth, which means Hengda equity wd be worth near zero to EVERRE. Tough outcome but so be it.

Sometimes analysis leads one to the point where one says "I don't see a good trade here".

I could point at iron ore, copper, Kweichao Moutai, the market for Chinese antiquities at foreign auctions, but for now, I just don't know.

Iron ore: property completions in 2022 come

from sales in 2021. Industry-wide they were still big. But people trade near-futures and spot with a longer outlook and forget about deliveries and calendar.

Copper? Who knows.

Kweichao Moutai? Personally, I'd be short here, but it is not super high conviction.