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Evergrande Real Estate – or Heng Da Group in Chinese – owns more than 1,300 building projects in more than 280 cities across China.
Founded by the former Chinese steel executive Xu Jiayin in southern China in 1996, it is now China’s second-biggest property developer by sales. Its businesses range from property development to wealth management. It’s also a familiar name to Chinese football fans as it owns the country’s biggest team – Guangzhou FC.
The booming business, which has tapped into many sectors of a growing Chinese economy, has also made Xu one of the richest members of China’s business elites: according to Forbes magazine, Xu has a personal fortune of around $10.6bn.
In short, mounting debt and changing regulation.
Evergrande’s trouble came after years of unrestrained expansion during which its debts grew alongside its size and assets. It is now labouring under a debt pile of more than $300bn.
Some analysts say Evergrande is now the world’s most indebted real estate developer. On Thursday, the company is due to make interest payments of $84m on its offshore bonds but lenders are not holding their breath.
The developer is also a casualty of Beijing’s changing approach to managing China’s gigantic economy. Shortly after he came to power in 2013, President Xi Jinping said that China needed to “shift the focus to improving the quality and returns of economic growth … to pursuing genuine rather than inflated GDP growth”.
Reducing the debt has become a major part of Xi’s effort to minimise systemic risks. It’s easier said than done but Beijing has been trying – for example, last year it introduced the so-called “three red lines” for selected developers, which severely limited their capacity to borrow.
In theory, the new rules would force the entire real estate sector to deleverage in order to improve financial health. They were initially seen as a welcome intervention by some, with UBS asset management saying early this year: “We have high confidence in the scope of these policies.”
In reality, things seem to be playing out in a messy way. Before the recent trouble, Evergrande had offered its properties at a discounted rate to ensure enough liquidity to keep the business afloat. But the music has stopped, with buyers losing confidence in an inflated property market ripe for a price correction.
Evergrande also put pressure on staff to lend it money. The loans were presented as high-interest investment schemes, but those who did not take part risked losing their bonuses. This month, Evergrande stopped paying back its employees. Now they are gathering on the streets outside the company’s offices, demanding their money back.
Evergrande’s share price tumbled by more than 80% this year. Credit ratings agencies have also downgraded its bonds.
For the government, the biggest fear is a potential spillover effect hitting the wider Chinese economy. The worsening geopolitical relationship with the west, Covid, as well as the strengthened ideological campaign to assert the influence of the ruling communist party in the economy have already led to fears of a sustained slowdown in the world’s second largest economy.
Reportedly, Evergrande also owes money to about 171 domestic banks and 121 other financial firms. Therefore, if the company defaults completely, there will be consequences for the banking system. A credit crunch could follow, analysts fear, which would be bad news for China and the global economy.
UBS estimates there are 10 developers with potentially risky positions with combined contract sales of 1.86tn yuan – or 2.7 times Evergrande’s size. In other words, Evergrande is only the tip of the iceberg.
Beijing is facing a dilemma. If it steps in to bail out Evergrande, what message will that send to other heavily indebted developers? If it does not help, the fallout could spread to other sectors of the economy.
The short answer is: it’s hard to tell. Nobody really foresaw the implications of the fall of Lehman Brothers more than a decade ago.
Not everyone thinks so: “A possible Evergrande default could be a significant drag on the property sector,” said Barclays analysts in a note. “But we think it is far from being China’s Lehman moment.”
Jimmy Chang, the chief investment officer at Rockefeller Global Family Office, thinks the ripple effect could extend beyond China. He told CNBC: “If China were to have a serious economic issue because of China Evergrande, the rest of the global economy would have contagion from it.”
Foreign holders of Evergrande’s dollar-denominated bonds – which total about $20bn – wouldn’t have much say in what happened and would therefore face a wipeout, analysts say. They would probably pursue their money in international courts.
Markets were spooked on Monday with America’s S&P falling 1.7% after Evergrande closed 10% down in Hong Kong – the lowest since May 2010. But the territory’s Hang Seng index recovered on Tuesday, closing up 0.5%, and the S&P has also regained lost ground.
The demise of the company is expected. If handled well, however, the process could inject momentum into Xi’s reform of the Chinese economy.
“We think it is difficult for Evergrande to meet its liabilities,” said Tao Wang, the chief China economist of UBS. “Project delivery will be most important from a social stability point of view. Hence, home buyers and suppliers are most important among its stakeholders.
“We think a possible scenario is segregation of project companies from the group to ensure the asset value is materialised and the cash flow is used for project construction only, whilst we expect a debt restructuring with a haircut will be needed,” she added.
There’s an expectation in China that Evergrande will not have the full backing of the government. The Global Times’s editor, Hu Xijin, said last week that Evergrande should not bet on a government bailout on the assumption that it was “too big to fail”.
But many Chinese households bought properties from the developer off plan. They may lose their deposits if the firm collapses.
Football fans may be disappointed, too. As the Evergrande saga unfolds, Guangzhou FC is also looking for government help. According to Bloomberg, the government in Guangdong is looking to take at least a 10% stake, and a state-owned company may step in to provide further assistance.
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