What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing over the past few months. Problems with over leverage in china's real estate sector have been exposed by the financial woes of evergrand group, the country's second largest property developer. Last week, they missed a 47 million dollar bond payment, which follows failure to pay a 83 million payment in the week prior things have gotten so bad that the hong kong stock exchange halted trading of the stock as the company explores restructuring action such as a potential Sale of their property management division - we don't know when shares, will begin trading again, but in the past the hong kong stock exchange has halted individual stocks for months at a time. For example, embattled state-owned enterprise, hua rong, has had shares halted since march of this year, while some of evergran's recent troubles can be attributed to mismanagement by the founder and chairman shuz yain.

They also are emblematic of structural problems across the country's entire property development sector. Last year the chinese government enacted new regulations to curb rampant speculation and leverage in the system. While evergrand was the first domino to fall, there are many other evergrants still operating in the country and for many of them, their days of reckoning are close on the horizon. On october 5th, another chinese property developer called fantasia, was declared to be in technical default after failing to pay a 206 million dollar loan payment.

This is despite them, telling investors just a few weeks ago that their liquidity situation was under control. Cynic holding stock was halted after its share price fell, almost 90 percent. In one day the company says it is facing severe liquidity problems and its ability to service. Its liabilities has almost been depleted in this video, we'll go over the latest two companies to default and try to determine just how bad this will be for the chinese economy.

We'll start off with the recent defaults of fantasia holdings, while they're not nearly as big as evergrand, there's still a significant player in the market, with over 100 billion chinese u.n of assets. They have dozens of active property developments, mainly in major metropolitan areas. According to their 2021 interim financial report, they appear to be in pretty good financial shape, their revenue increased to almost 11 billion chinese yuan and they recorded more than 300 million in net profit and, unlike evergrant, their balance sheet seemed to be in pretty good shape. Their 110 billion chinese yen of assets far exceeded their roughly 80 billion of liabilities, so they should have been more than able to manage their debt.

In fact, a few weeks ago, as the evergrand situation was unfolding, fantasia reassured investors that they had ample liquidity to make good on their obligations. But fantasia's confidence in their financial position turned out to be little more than a fantasy. It turns out that a wholly owned subsidiary of fantasia engaged in a financial transaction with country garden holdings, which is china's largest property developer as part of their agreement. Fantasia's subsidiary, was contractually obligated to make cash payments to country garden.

On october, 4th country garden released a statement saying that fantasia defaulted on obligations under the contract worth 206 million dollars. As a result, they'll take control of some of fantasia's assets which are put up as collateral. The most shocking part about this situation is that fantasia did not disclose their liability to country garden anywhere on their financial statements. Investors who read fantasia's financial reports believe that they were solvent because their assets exceeded their liabilities, as it turns out the numbers on their balance sheet significantly understate their total liabilities.

They could easily have many other financial arrangements similar to the one with country garden, which are also not disclosed. We have no idea how big fantasia's, true liabilities are, and they could easily be insolvent. Shares of fantasia were hauled in on september 28th, after losing more than half of their value since the beginning of this year, given that they are technically in default, it's possible that their common equity could end up being worthless. Another thing that's concerning is that chinese property developers seem to be very interconnected.

Larger developers, like country garden, enter into opaque off-balance sheet arrangements to supply capital to smaller developers like fantasia. This provides a mechanism for contagion whereby bankruptcies of some developers put financial strains on their creditors. This could be roughly analogous to how the collapse of lehman brothers put the entire global financial system under distress, because they are so interconnected with so many counterparties, and it appears that there are still dominoes left to fall among the chinese property developers. Sinek holdings is roughly the 35th largest property developer in china, with 28 billion chinese yen of revenue in 2020.

On september 20th, they requested that the hong kong stock exchange halt trading of its shares in anticipation of the release of important corporate information. Whenever a company has insider information that has not yet been released to the public, it is not uncommon for them to halt shares to prevent insider trading. While the market didn't know what this corporate announcement would be, it was pretty safe to assume that wasn't going to be good. Given the backdrop of the evergrand crisis, shareholders rushed to dump their shares right after the trading halt was announced and the stock price fell by 87.

On their last day of training on september 30th, they made the anticipated announcement. They said that unfavorable macroeconomic conditions had caused a liquidity crunch and they missed the payment to an onshore creditor worth 39 million chinese yen. The creditor also exercised an option to demand repayment of 75 million us dollars worth of principal and accumulated interest with the evergrant situation. Unfolding chinese home buyers are understandably hesitant to hand over down payments for new properties if the developer goes bankrupt before the property is completed.

The home buyer will end up holding the bat with an unfinished property that could be worth much less than the down payment. The real estate developers rely on new pre-sale down payments to fund the construction of existing developments. This leads to a self-fulfilling prophecy of failure. Buyers are scared, so you don't buy new pre-sales.

This causes a liquidity crisis for the developer and they can't finish their existing projects, thus confirming the fears of the hesitant potential buyers. According to investment bank nomura, new property sales in china fell 24 in the month of august on a year-over-year basis, and new land sales have fallen more than 50 percent. These numbers will probably get even worse, as fear in the market has only increased this broad-based decline. In sales may drive many real estate developers into a liquidity crisis, even if they would have been able to survive and even be highly profitable under normal market circumstances.

The question now becomes how many evergreens are still out there like powder kegs waiting to explode. The real estate sector accounts for almost 30 percent of china's gdp. When you take into account construction property management, realty services and raw materials, a significant slowdown in the market could see the world's second largest economy fall into a painful recession. Perhaps the most important company to monitor is country garden holdings, which is the country's largest property developer.

As measured by revenue, a potential failure of country garden would be a devastating blow to the chinese economy, both because of their large size and their interconnectedness with other developers. For example, we know that they are involved in financial transactions with fantasia which were defaulted on. It's possible: there are significant capital provider to smaller real estate developers across the country. The good news is that country garden has significantly less leverage than evergrand.

Over the past couple years, they've been using excess cash flow to pay down their debt burden, which now sits at 324 billion chinese yuan, but their debt burden is still significant. They have about 2 trillion chinese unworth of total assets and 1.74 trillion chinese yen worth of total liabilities. This means that their shareholders equity is only about 14 of their total assets, which doesn't give them a very big margin of safety, but these numbers have to be taken with a little bit of a grain of salt. Remember that fantasia's balance sheet looked like a fortress until it was revealed that they had significant liabilities which they failed to disclose on their audited financial statements.

One thing we do know about country garden is that they have historically been willing to invest billions of dollars in highly speculative and risky developments. For example, they invested billions of dollars in the forest city, artificial island development in malaysia, but a worsening of china, malaysia relations and coveted travel restrictions turned this development into a complete disaster. It currently has about 500 active residents compared to a capacity of 700 000. These types of over-the-top projects exemplify the excesses which have built up the chinese real estate sector over the past decade.

If country garden can get through this time of distress in the industry, the chinese economy will probably be fine and only suffer a modest and temporary slowdown. In growth, but if country garden ends up being the next ever grand, it could be a whole other story. We will be monitoring them closely over the next few months, alright guys that wraps it up for this video. What do you think about the unfolding meltdown in the chinese real estate industry? Let us know your thoughts in the comments section below as always.

Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.