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As Evergrande Prepares To Sell Property Management Arm, China's Mitigation Strategy Likely To Hang Foreign Bondholders Out To Dry

Evergrande's HQ

As China's Evergrande Group continues to miss payments on debt obligations to foreign lenders, both the company and the Chinese government are prioritizing domestic stakeholders.

Evergrande, the most indebted developer in the world, with $305B in liabilities, halted stock trading for itself and its property management subsidiary, Evergrande Property Services, ahead of what it called news of a pending "major transaction," Reuters reports. Chinese state-run media reported that the transaction would be the sale of a majority interest in Evergrande Property Services to another Chinese developer, Hopson Development Holdings.

The sale, reported to be worth as much as $5B, would be the largest move Evergrande has made yet to raise liquidity to pay down some of its debt, Reuters reports. It also would reflect the preference of the Chinese government to transfer as much of Evergrande's business to more financially healthy companies, The Wall Street Journal reports. Hopson, which reported revenues of $2.1B in the first half of the year, is considerably smaller than Evergrande, but is profitable and has more assets than debt, in line with China's directive to the country's real estate market to de-leverage.

Stripped of its ability to raise more debt capital, Evergrande has been unable to pay various obligations, but the People's Bank of China has prioritized the repayment of the developer's suppliers and contractors, as well as homebuyers who have made down payments on under-construction units and retail investors who purchased high-return investment products from Evergrande, Bloomberg reports.

A state-run entity bought out Evergrande's ownership stake in a domestic commercial bank on the condition that Evergrande use it to pay prioritized groups, while PBOC has injected $123B of short-term capital into the domestic financial market to ease liquidity concerns, Bloomberg reports. All the while, state finance officials have been directing banks to ease credit for homebuyers and otherwise prop up the domestic real estate industry.

A project being developed by Evergrande in the Chinese city of Yuanyang

Every decision that Chinese leadership has made to this point indicates its strategy is to let Evergrande itself fail and contain the fallout so it doesn't tank the entire real estate sector, which makes up a disproportionate share of the country's economy, Bloomberg reports. The focus on domestic financial health likely will mean that foreign financial entities that have purchased Evergrande bonds may see the value of those bonds wiped out, analysts told Bloomberg.

How much pain will be felt in financial markets outside of China could be determined by the country's success in limiting contagion from Evergrande's looming collapse. Another Chinese developer, Fantasia Holdings Group, announced that it failed to repay $206M of a $500M loan originated in 2016 that came due on Monday, Reuters reports.

Chinese state finance officials have directed its banks not to halt lending to real estate companies all at once, but Fantasia is not the only developer to report imminent financial distress either similar to or at least partially caused by Evergrande's situation. If the country lets those companies fail, redistributes their projects to other companies and intervenes to ensure domestic investors are made whole, then more European and U.S. financial entities are at risk of seeing their bond investments in Chinese real estate go up in smoke.