October 21, 2021
Attempts to save Chinese property giant Evergrande, the country’s second-biggest property developer, have run into trouble, leaving the company facing a default that could cause a damaging ripple effect across the Chinese property market and beyond.
The company missed a deadline in September for a $83.5 million bond interest payment, and a 30-day grace period is set to expire on Saturday. The company has since missed further offshore bond payments totalling $193.3m. If the Saturday deadline is not met, the company will officially go into default, with unpredictable consequences for the Chinese economy and foreign investors. Evergrande’s total debts are in the region of $305bn.
Evergrande has attempted to use the grace period to sell assets to raise capital for its debt repayments. These included a 51% stake in the company’s profitable property management arm to Hopson Development Holdings, another Chinese developer, for $2.6bn, and its 26-floor waterfront headquarters in Hong Kong for $1.7bn. However, both of these sales have fallen through due to a lack of approval from the Guangdong Provincial Government, which is overseeing the restructuring of the company.
Founded in 1996 in Guangzhou Province by businessman Hui Ka Yan, Evergrande has been a major beneficiary of China’s relentless rapid growth, operating on a debt-fuelled borrow-to-build model that grew the company into a real estate empire that owns more than 1,300 projects in over 280 cities across China. The company also has interests in wealth management, electric cars, and food and drink manufacturing, and owns Guangzhou FC, one of China’s biggest football teams.
However, last year Chinese regulators introduced new rules to rein in corporations with excessive debt, known as the “three red lines” policy, which places limits on corporate debt in terms of cash flow, assets, and capital. This left Evergrande unable to borrow enough to cover its debts, prompting the current liquidity crisis. A default for Evergrande would possibly trigger a domino effect for other Chinese property developers, many of which operate along a similar business model. Numerous other smaller developers have already defaulted on offshore bonds, to an estimated total of 47bn yuan ($7.3bn) this year, according to Chinese property consultancy CRIC.
Coming amid regulatory crackdowns on a wide range of sectors, these regulations form part of President Xi Jinping’s attempts to focus the Chinese economy on strategic and productive results, rather than freewheeling profit margins. Shortly after becoming President in 2013, Xi said that China needed to “shift the focus onto improving the quality and returns of economic growth … onto pursuing genuine rather than inflated GDP growth.” In this context, the targeting of the property sector makes sense, as the bloated Chinese housing market represents up to 25% of Chinese GDP, fuelled by cheap decades of cheap credit.
This has left investors nervous about how far the Chinese government are willing to go to save Evergrande. The Chinese Central Bank is injecting vast amounts of liquidity into the market, and banks have been instructed to keep lending to financially solvent firms, but President Xi may be willing to punish Evergrande itself, to serve as an example to other companies using the “speculative” model.
According to analysts, the government’s priority in this case would be to protect the small investors, regular citizens who were pre-sold an estimated 1.4 million properties that are not yet finished. Small scale suppliers and contractors will have to wait and see when they will be paid; the company is said to be offering property as payment-in-kind in the absence of cash. For foreign investors however, who hold dollar-denominated offshore bonds of around $20bn in total, the outlook of such a situation is bleak, and would probably involve a wipe out.
The unpredictable question is whether such a high-profile collapse would trigger contagion, and how far that could spiral. The total value of housing sales fell 19.7% year-on-year in August, and a further 16.9% in September, as demand shrank due to the uncertainty. This puts many other developers at risk of default, and concerns about excess debt could spread to other sectors; China’s corporate debt accounts for around a third of the global total, around $27tn. President Xi is using hardball tactics to bring China’s economy to heel, but if the gamble doesn’t pay off, the country could be facing a severe credit crunch, with far-reaching economic and political consequences.
