Liquidation, finally!

That Evergrande would end up in liquidation was never much in doubt, but here we finally are! Huge news out of Hong Kong, and the next few months will certainly be filled with interesting tidbits about the process unfolding.

This is very much a story of how authoritarian governments don't respect and can't work with areas with rule of law; how authoritarianism breaks down legal systems, rule by rule. For months this case couldn't move forward, because Beijing refused to act, or to at least ameliorate the effects of this crisis.

Then the government arrested Evergrande's CEO for corruption, which was quite counter-productive at that moment. As I've mentioned, the state could easily soak up whatever wealth is left through civil and criminal fines and judgments, leaving suppliers and investors, not even considering the overseas bondholders, with nothing.

Now we have a Hong Kong ruling, but that ruling will only be effective if the authoritarian government in China approves. Even then, honestly, it will be a struggle, if the state doesn't want to play ball than this will go nowhere. Even if the central government is on board, the local areas have significant incentives not to work with the liquidators. That means the local party, the local courts, and in theory local business leaders, (suppliers, possibly?), any one of which could throw a spanner into the works.

To start off we need to recognize that the bankruptcy of the Hong Kong subsidiary is not a processing of the entire Evergrande empire, indeed it is only a small portion of the whole. The subsidiary likely never contained sufficient assets to equal the loan amounts. Certainly the assets will not be adequate to repay the loans in full now, and the costs of acquiring and selling each and every Mainland asset will be costly and time-consuming.

All this is also assuming that the government allows any process at all.

China's government could have already done so many things to manage this crisis, and hasn't acted, at least not in a formal way, or in ways to protect stakeholders. Instead, they've apparently handed entire projects to municipalities, presumably as assets stripped of underlying, related debt. It's hard to imagine that a Hong Kong judge could disrupt the government's timeline like this. Yet another ideological struggle.

This CNN article gives us insight into how the larger part of Evergrande is doing:

[Xiao En, CEO of Hengda] also said that the liquidation order doesn’t affect the operations of subsidies that are “independent legal entities,” including its main property development business, Hengda Real Estate Group, which has most of its assets in mainland China.

...Evergrande has been building and selling apartments in mainland China, even though it has been unable to repay its debts.

By February 2023, the company had completed and delivered a total of 421,000 homes across the country over a 14-month period, according to a stock exchange filing published last March.

Later in the article we find out how that is funded:

Last week, Xiao Yuanqi, deputy head of China’s National Financial Regulatory Administration (NFRA), said that nearly 350 billion yuan ($49 billion) in special loans for guaranteeing delivery of unfinished homes have been issued since 2022. Commercial banks have also provided financing to developers to ensure delivery of unfinished homes can be achieved.

I'm feeling more sympathetic to this process than I had been. While this is clearly good money after bad, and these loans are not loans but a bailout, there is a sense that it is more efficient to have Evergrande itself finish construction. Certainly the process (and time) involved in shifting to another entity would be costly.

Still, these are more loans the banks are creating that will not be paid back unless the government steps in. A banking crisis would be a very natural result of a large number of loans losing significant value.

One big thing the Chinese government could have done, something that the US government does from time to time, would be to force a sale of some of the random parts of the Evergrande empire, such as the EV subsidiary.

The role of selling these assets should be managed by the liquidators, but I definitely have sympathy for a position that speed is most essential in a crisis such as this, and sometimes, politics can move faster than legal systems. Instead, the assets of that EV company are likely sitting idle, without the capital requirements to utilize them.

The same holds true for the previously-mentioned projects transferred to the municipalities. In theory it is a good solution, having the advantage of, again, speed. However the obvious provision necessary is a proper accounting and some payment for the projects. But will Beijing respect and value the legal niceties? Or will they make their own decisions on resolution, at a timing of their choice?

Another interesting issue is that the liquidators, if they are not aided by an activist government, will need to go to every local area to establish control over each asset. The central government could facilitate this to a high degree by setting up an entity to collect the ownership of these properties, and by directing local government and the courts to finalize the transactions. I would not expect such steps to be taken, but one never knows.

I also note now that we have some certainty that most of the unfinished apartments will be finished (a good thing certainly), we should recognize that as that process winds down there will be quite a lot of slack construction labor, a problem I've been thinking about recently. There should be a very shallow market for new construction in 2025.