Country Garden Holdings (HKG: 2007) (OTCPK: CTRYF) shares are down by 17% again. 2007 shares dropped as a a result of fairly doom laden news released over the weekend - that certain bonds would be suspended from trading. The important point here is that these are domestic bonds. If we were to be unkind about the Chinese financial markets we’d suggest that foreigners losing money is not something that anyone internally worries about very much. But people within the country, on the Mainlaind? That then becomes a more important problem.
So, there were a couple of missed coupon payments on international dollar bonds last week. That’s something that might be regarded as regrettable but not wholly important. But wen it’s domestic bonds, that’s different: “Shares in Country Garden slumped to a record low on Monday after the Chinese developer suspended trading in at least 10 of its mainland bonds, spurring a wider sell-off in property-linked stocks. The company, formerly the largest developer in China by sales, missed international bond payments last week in a sign that a two-year liquidity crisis across the real estate sector was threatening to escalate.”
The worry then becomes: “Markets remain jittery as the trouble in China's largest private property developer could have a chilling effect on homebuyers and financial institutions, further dampening the prospect of a near-term recovery in the sector and the broader economy.” Yes, China Garden is big enough to affect the entire sector - and yes, the sector is big enough to affect the entire Chinese economy. Which then brings in the major risk factor here - politics.
In pure business terms, absent some large scale change in macroeconomic policy, Country Garden is toast. But that’s the problem at Country Garden: “The basic background here is that the bond prices are shrieking that Country Garden (both versions) is bust. One day just recently the $ bonds were trading at 20% of par. That’s not just akin to Chapter 11 value (not that China calls it that but…) that’s below the usual sort of range we’d expect in a Chapter 7, or liquidation.” The economics of this is fairly simple. But politics and Country Garden: “The big question being, well, is there going to be that government support for the sector or not? It’s even possible that government will support the sector but not the companies.” And back a bit further, yes there was thought that there would be government support for the sector and Country: “As we did say about Country Garden Services: “Well, what can be done? At this point there are really only two things that are possible. The first is that there is general support to the sector. Preferential interest rates, general economic stimulation, Keynesian demand management and all that. The problem here is that this has all been done, multiple times, in past years. It may not be that Austrian economics is wholly true all of the time but in extremis that argument that bubbles will pop and that they need to pop is indeed true. Which leads to the second possible thing. The Chinese authorities agree that the bubble has popped and so allow large numbers of people to go bust. Of course this will be a managed process. But managed in whose favour? “
That’s what the risk is here. Not that Country Gardens is going to go bust - that’s already happened, the question is whether the formalities will follow reality or not. Will the Chinese government change macroeconomic policy to support the property sector or not? The risk that it will is, in our minds, the only risk that Country Garden is not heading to zero and rapidly.
