Teetering property developer Evergrande sparks fears instability will spread through China's economy
Company with $300 billion US debt load poised to miss key interest payment Monday
Property developer China Evergrande Group is teetering on the brink of collapse, weighed down by a giant debt load and billions of dollars in real estate it can't sell as quickly or as profitably as anticipated.
While trouble has been brewing for a year, it's coming to a head now, as the conglomerate missed one loan payment in June and more are expected. Evergrande's offices were the site of angry protests this week, and things could get even uglier on Monday when the company is likely to miss another key interest payment to its increasingly concerned financiers.
Evergrande's possible collapse is sparking fears that it could take other parts of China's housing market down with it — and impact business interests outside China, too.
Here's a brief explainer of what you need to know about the story.
What is Evergrande?
Founded in 1996 in the Chinese city of Shenzhen, across the border from Hong Kong, Evergrande is mostly a property developer whose core business is buying up land and turning it into residential real estate. Company founder Hui Ka Yan is a former steel worker who rode China's 21st-century real estate boom to a fortune that was at one point last year worth $30 billion US, good enough for the title of third-richest man in China.
The company has built more than 1,300 housing developments in 280 cities in China, with plans for another 3,000 projects underway in various cities across the country.
But like any good conglomerate, it has expanded into all sort of other businesses, including bottled water and food, electric vehicles, theme parks, a Netflix-like streaming service with almost 40 million customers — and even a professional soccer team.
Why is it in trouble?
Debt — and lots of it. The company has almost two trillion yuan of debt on its books, the equivalent of more than $300 billion US. The company aggressively borrowed money to buy more land to develop, and sold apartments quickly at low margins to raise enough cash to start the cycle again — which works fine as a business model, until it doesn't.
In late 2020, new rules that brought more scrutiny to the company's finances revealed higher-than-expected debt loads. That, coupled with mounting construction delays, spooked buyers, setting up a vicious cycle. The company began its descent to pariah status as lenders and buyers lost their nerve in lockstep with each other.
Every attempt by Evergrande since then to distract from its problems only served to draw more attention to them. Lenders became more and more unsettled. Existing owners got upset. New sales slowed, which created a feedback loop that got lenders even more jittery.
In June, the company admitted it missed payment on a loan. The next month, a Chinese court froze a $20-million bank deposit at the request of one of its lenders. At least one creditor, a paint supplier, is reportedly being paid in apartments that won't be ready until 2024.
According to data compiled by Bloomberg, on July 19, presales at two projects in Hunan were halted. Three days later, Hong Kong banks stopped offering mortgages on any incomplete projects by the company in the city. On Aug. 9, two more projects in Kunming stopped construction due to missed payments, followed by similar halts at projects in Nanjing and Chengdu. Things have snowballed ever since. The company's stock price has cratered by 90 per cent in the past year, and most of its bonds are in junk status.
The company is behind on its obligations to more than 70,000 investors. More than one million buyers of unfinished projects are in limbo. And the pace of problems is picking up. "Sales could slump further as the developer may struggle to restore potential homebuyers' confidence," said Lisa Zhou, an analyst with Bloomberg Intelligence.
Monday figures to be an inflection point for the company as Evergrande is supposed to make an $80-million interest payment on one of its many loans, and there's next to no chance it will pay that — which could start the clock ticking toward some undesirable outcomes.
What could happen?
A number of bleak B words are on the table — bankruptcy, breakup, buyout or bailout — and none of them are ideal.
The first option would be the most painful.
"If, as expected, Evergrande is defaulting on its debt and goes through a restructuring, I don't see why it would be contained," Michel Lowy of distressed debt investment firm SC Lowy, told Reuters.
But because of the Chinese government's long-standing desire for stability, that's also the least likely outcome. The company owes money to 128 different banks and was behind almost one out of every 20 property sales in China in the past five years. Evergrande permanently employs almost 200,000 people but hires almost four million people a year to work on various projects.
With a reach that wide, analysts who cover the sector are confident that Beijing won't let the company simply collapse. "Evergrande's escalating crisis may prompt government action to prevent social instability," Zhou said.
More likely is some version of the next two options, a breakup or buyout, where the company sells assets to raise cash and help is brought in to run things. "State-owned enterprises or other developers may also take over Evergrande's projects, after Chinese officials sent accounting and legal experts to examine the company's finances," Zhou said.
A full government bailout, however, is just as unlikely. China has been cracking down on its high-flying technology sector, trying to regulate and ban cryptocurrencies and reining in excesses in all sorts of sectors. Evergrande's problems may be a test case in Beijing's desire and ability to manage every facet of the growing economy.
Bank of Montreal economist Art Woo said in a note on Friday that he also doubts a bailout is coming. "As for who could bear the losses, that's frankly tricky to predict, but we think it's reasonable to believe that the authorities are unlikely to bail out equity holders or creditors in an effort to prevent moral hazard from increasing and improve financial discipline," he said.
More likely is some sort of organized wind down, to keep damage to a minimum. "We do not believe the government has an incentive to bail out Evergrande (which is a private-owned enterprise)," Nomura analyst Iris Chen said in a note to clients.
"But they will also not actively push Evergrande down and will supervise a more orderly default, if any, in our view."
Is there an impact outside China?
Not much, directly, although Evergrande does have assets in Europe and North America — including the ritzy Château Montebello resort in Quebec — but the company's woes are nonetheless a cautionary tale for people everywhere.
China has been in a housing boom for more than two decades, as more and more people put money into residential real estate — almost regardless of the price and demand for the underlying asset.
Video went viral on social media this month of a 15-tower condo development in Kunming being dynamited to the ground because it was a ghost city with no actual residents, eight years after being built.
While that wasn't an Evergrande project, the worry is that there are many others out there like it.
Re-upping the stunning demolition videos showcasing housing oversupply in China: 15 skyscrapers in China that were part of the Liyang Star City Phase II Project were just demolished after sitting unfinished for eight years due to absent market demand. <a href="https://t.co/UByqjk8QXX">pic.twitter.com/UByqjk8QXX</a>
—@Jon_Hartley_China's Lehman Brothers moment?
The 2009 financial crisis was sparked by the failure of two investment banks, Bear Stearns and then Lehman Brothers, which exposed just how much bad debt there was in the system and caused a chain reaction of worry down the line
That may be far fetched for the economy as a whole this time around, but it's certainly on the table for China's housing market at least.
"Lehman [was] very different as it went across the financial system, freezing activity," said Patrick Perret-Green, an independent London-based analyst.
"Millions of contracts with multiple counterparties, everyone was trying to work out their exposure," he said. "With Evergrande, it depresses the entire real estate sector."
"There are other developers that are suffering from the same problem of no access to liquidity and have extended themselves too much," Lowy said.
Simon MacAdam, an economist with Capital Economics, says the Lehman parables are unwarranted.
"The China's Lehman moment narrative is wide of the mark," he said. "Even if it were the first of many property developers to go bust in China, we suspect it would take a policy misstep for this to cause a sharp slowdown in its economy."
Regardless, the Evergrande saga is a cautionary tale about the down side of unrestrained real estate speculation anywhere.
As Woo put it: "A default or bankruptcy does not pose a Lehman-type threat ... but it's still bad news for the economy."
ABOUT THE AUTHOR
With files from Reuters