China's Lehman Moment Approaches...

As we reported this morning, police descended on Evergrande’s Shenzhen headquarters late Monday after dozens of people gathered to demand repayments on overdue wealth management products. Protesters numbered in the hundreds on Sunday, Caixin reported. In addition to equity investors who are about to lose everything, the company is also facing angry homebuyers, creditors and even its own employees... who are also about to lose everything.

“It looks like they are working on debt restructuring after no concrete results on asset disposals, and the first task is to stabilize the holders of wealth management products which could be a social issue,” said Daniel Fan, a credit analyst at Bloomberg Intelligence. “It seems the developer is working on rescheduling pretty much all onshore debt, and the next step is to do the same for offshore investors.

Translation: a bond default is imminent, and the only question is what will creditors get in return.

How imminent? According to Bloomberg, two units failed to discharge their guarantee obligations on time for wealth management products worth 934 million yuan ($145 million), the company said, adding it’s in talks with issuers and investors on a repayment arrangement. If the company fails to reach a resolution, it's all over and the bankruptcy process begins.

And while distressed investors are already circling the company's dollar bonds which are trading around 25-30 cents on the dollar, with the market pricing in a potential restructuring, this is an especially risky proposition according to Citigroup. According to the bank, the insolvent developer’s bonds are trading at levels that attract the type of investors who place bets on the hardest-hit companies, but dollar bond holders may not be prioritized in a debt restructuring and a resolution could take years, Citi warned.

“We caution that offshore holdco debt is deeply subordinated to onshore secured bank debt and opco debt, and recovery values in any restructuring could be low,” wrote Citi strategist W.R. Eric Ollom.

“Disposition of Evergrande’s substantial land bank to meet creditor claims could be lengthy, resulting in stretched out legal proceedings.”

Citi also speculated that a solution for Evergrande may include forced core asset sales as well as haircuts for some classes of debt - notably dollar-denominated ones - the Citi strategists wrote, noting that Evergrande’s offshore bonds may be treated as subordinated to bank and opco borrowings in an onshore restructuring. Meanwhile, Nomura credit analyst Iris Chen said a debt restructuring is “almost unavoidable,” predicting a base-case scenario where bondholders would recover 25% of their money.

And while Evergrande's bonds can't really fall much more from here, and in fact are prone to short squeezes, the same can not be said for its peers, and as Evergrande stock plunged again, dropping as much as 8.6% to a the lowest since 2014, it also dragged fown lenders and companies that previously disclosed large revenue exposure to the developer after the news that bankruptcy advisors had been hired.

Expect much more pain once the company finally pulls the plug, and China's Lehman moment arrives.

China Evergrande Group, one of the country's leading developers, has denied rumors about its bankruptcy and reorganization, claiming they were "totally untrue", Beijing Daily reported.

At present, Evergrande did face unprecedented difficulties, but it will fulfill its responsibilities for its enterprises, resume work, production and normal operation, and safeguard customers' legitimate rights and interests, the company said in a statement on its website late Monday night.

In another separate statement filed with the Hong Kong stock exchange on Tuesday, Evergrande said two of its subsidiaries had failed to discharge guarantee obligations for 934 million yuan worth of wealth management products issued by third parties.

That could "lead to cross-default", which would "have a material adverse effect on the group's business, prospects, financial condition and results of operation."

In order to solve the repayment problem in wealth management products, Evergrande provided three solutions for investors, including cash payment by installments, and using housing, apartments, office buildings, shops and parking spots as repayment assets.

Evergrande Group Chairman Xu Jiayin said last week the company will ensure the repayment of due wealth management products as soon as possible, and "not a penny less".

Shares of the company fell nearly 9 percent early on Tuesday, and its shares fell 11.57 percent or HK$0.39 to trade at HK$2.98 at 2 pm.

Well, in this delightfully absurd world we live in, that's just what happened only instead of Evergrande making the announcement, it was the entity that will soon control the massively overlevered property developer that made it for them: the Chinese government.

According to Bloomberg, Chinese authorities told major lenders to China Evergrande Group not to expect interest payments due next week on bank loans, which takes the cash-strapped developer a step closer the nation’s largest modern-day restructurings, and guarantees that China's "Lehman Moment" is now just a matter of days, if not hours.

According to Bloomberg, citing unnamed sources, the Ministry of Housing and Urban-Rural Development told banks in a meeting this week that Evergrande won’t be able to pay its debt obligations due on Sept. 20, and instead most of Evergrande’s working capital in now being used to resume construction on existing projects, the housing ministry told bankers, according to a Bloomberg source.

And since nonpayment of interest and principal will represent an event of default, the company is unlikely to make any subsequent interest, or principal, payments either since it will have already default even though Bloomberg claims that "Evergrande is still discussing the possibility of getting extensions and rolling over some loans." It won't, especially since the developer will also miss a principal payment on at least one loan next week, which means it's game over.

Meanwhile, as reported previously, Chinese authorities are already laying the groundwork for a debt restructuring of the $300 billion company (which recently hired Houlhan Lokey to advise it during the upcoming historic bankruptcy), assembling accounting and legal experts to examine the finances of the group.

Property development has been a huge factor in China’s economic growth. It accounts for 28% of GDP. And much of it has been funded by debt, including dollar-debt, and much of it is now blowing up.

Foreign investors piled into the property sector over the years, buying hundreds of billions of dollars in bonds, including dollar bonds issued by China’s property developers. They bought those bonds because they liked those yields, in some cases over 10%, thinking that the Chinese government wouldn’t let those companies default, that it would bail out the bondholders as it bailed out so many bondholders before, and surely it would do it again, given how crucial the funding of the property sector is to the Chinese economy.

And now just about everything has gone wrong for these foreign investors. For months, there has been a massive crackdown by Chinese authorities on liquidity-driven inflows into the housing sector.

Authorities cracked down on overleveraged property developers. They targeted mortgage approvals and interest rates for first-time buyers. They tamped down on rental growth. They pushed banks to reduce their lending to homebuyers. A national property tax has been put on the table.

And this was topped off with an increasingly strained relationship between the Chinese government and the United States government, that includes major steps by the US government to crack down on speculation by Chinese entities in the US stock markets.

China’s crackdown on property speculation is guided by the official mantra that “housing is for living, not for speculation.”

That massive amount of speculation and leverage has for years posed enormous risks to financial stability. And the government is now trying to defuse those risks – and it looks like at the expense of foreign investors that have bought those hundreds of billions of dollars in bonds.

Those foreign investors are suddenly realizing that they’re no longer sacred and that the government may not bail them out.