For years, investors happily bought into the dollar bonds of Chinese real estate developers, betting that the biggest and most aggressive would become too big to fail. Even during the global market sell-off in March, private bankers told their wealthy clients not to worry. In the worst case, they could just hold those notes until maturity and enjoy the juicy coupon payments.
China Evergrande Group's recent tumble is a wake-up call. Beijing's latest policy shifts show it is confident that killing a dragon or two won't cause a wildfire.
Evergrande, one of the country's largest developers with 2.3 trillion yuan (S$463 billion) in assets, faced a crisis of confidence late last week. A dramatic sell-off in its stocks and bonds followed reports that the company had sent a letter to the Guangdong government warning of a potential cash crunch if it couldn't carry out a backdoor listing in Shenzhen by next January. The company said in a filing that the document was "fabricated".
Nonetheless, investors were unnerved. The document, fake or not, struck the right note. Just over a month ago, Beijing proposed a "three red lines" approach for major developers. Those exceeding all three leverage metrics monitored by regulators are forbidden from borrowing more. Evergrande has solidly crossed that threshold.
In that "fabricated" document seen by Bloomberg Opinion, Evergrande threatened systemic risk (835.5 billion yuan in borrowings), bankruptcies of its business partners and job losses. These are among the reasons why it must go public.
But there is no systemic risk. Rather than cracking down on the entire industry, the new "three red lines" policy is very targeted.
Out of the 334 developers likely subject to the new rules, only 50 of them, accounting for 36 per cent of total industry borrowing, failed all three criteria, according to Gavekal Dragonomics. Meanwhile, developers accounting for just under half of total debt passed all three tests. Similarly, of the 18 largest developers tracked by Bloomberg Intelligence, 11 are in the green zone and can raise their borrowings by 10 to 15 per cent each year.
In other words, even if Evergrande fell on hard times, other big developers could just come in and carve off its assets. In fact, this is what China Vanke is doing with Tahoe Group, the first large developer to default on a bond in five years. Developers have a lot of hard assets. Land banks can be sold, senior lenders will get paid, and the rest will have to soak up losses. They don't need to be bailed out by the state.
Amid China's deleveraging campaign two years ago, Vanke said its goal for the next three years would be simply "to survive". That startling slogan turned out to be prescient and was followed by a broader bond sell-off in the sector. Last weekend, its chairman Yu Liang came out talking again.
In his view, China's real estate market can be divided into three stages. In the 1990s, those with the right political connections were able to get land cheaply. The auction system implemented in 2002 upended that. Since then, those with the appetite and access to bank loans and shadow financing were the winners. Starting next year, only good governance will matter, Mr Yu said.
Heed his words. Over the years, Evergrande has seemed like a cat with nine lives, living dangerously with a whopping 47 per cent of its borrowings due within a year. Perhaps its good fortune is coming to an end.
• The writer is a Bloomberg Opinion columnist covering Asian markets.