The rise and fall of Evergrande

Hengda Group (now known as Evergrande) was founded in 1996 by Hui Ka Yan as a real estate development company based in Guangzhou, Guangdong province, and went public on the Hong Kong Stock Exchange (HKEX: 3333) in November 2009. Evergrande has expanded nationwide to become one of the largest players in China’s real estate industry, owning more than 1,300 real estate projects in 280 cities. During its time of prosperity, it has not only become a real estate giant, but also a massive multi-industry conglomerate, with businesses in new energy vehicles and healthcare as well as having invested in football and tourism companies.

Hui has been able to dramatically grow his empire in the last 2 decades for the following 3 reasons:

The Chinese economic boom

The first and most obvious reason is the rapid growth of the Chinese economy. The primary impact to the real estate sector has been the huge urbanisation of the country, with urban percentage going from 26% in 1990 to over 61% in 2021. The massive influx of citizens moving from rural regions to major cities has meant the extensive demand for apartments and homes.

Opportunity

During the 2008 Financial Crisis, the government flooded the economy with money as they issued a RMB$4 trillion stimulus package. This made lending very cheap and easy, allowing Evergrande to scale up the volume of projects under their purview.

Alignment with the government

Hui has been depicted as being savvy about how he has expanded his business by aligning his investments and his growth and expansion into property alongside the agenda of authorities.

Starting in late 2015, there was this greater emphasis on curbing the amount of debt in the Chinese system not only in terms of the volume, but the pace at which it is accumulating at. China’s national debt was recorded at 270.1% of GDP at the end of 2021. But how has this debt been accumulated? Infrastructure.

America has been in the news lately due to the battle to pass the infrastructure bill. Theoretically, infrastructure projects should be positive. In the short term, roads and bridges get built, and these projects will put money into the people’s pockets, and alleviate unemployment. In the long term, these projects will provide value to the economy. The Golden Gate Bridge (20+ million vehicles served a year) and the Hoover Dam (providing cheap hydroelectric power to the west coast) are great success stories. Governments fund these infrastructure projects by increasing taxes but more often issuing government bonds.

Normally, when a government decides to go ahead with an infrastructure project, it goes onto the government balance sheet. This is where China differs. China’s infrastructure projects are handled by state-affiliated companies – and hence do not appear on the government’s balance sheet. In addition, China’s haste to upgrade its infrastructure has led to the substantial build-up of debt.

A big part of the debt problem lies in China’s real estate sector, which accounts for about 30% of

the country’s dollar-denominated bonds.

This cycle has led to massive amounts of debt, with excess projects of houses that are empty and not getting purchased. The firm itself has more than $300 billion in liabilities. Now that includes roughly $19 billion of bonds that are owed to offshore or global investors, as well as about $8 billion worth of domestic bonds that are owed to local investors in mainland China.

Evergrande is also said to have private placements, which are essentially hidden or sort of opaque types of debt that have been sold to just a small group of investors. Scrambling to repay its mounting debt, the company sold some assets and Hui was also asked by the government to use his personal wealth to pay debt.

To curb reckless borrowing, in 2020, Chinese authorities drafted three red lines-metrics regarding debt that developers will have to meet if they want to borrow more. 

1. Liability-to-asset ratio (excluding advance receipts) of less than 70%
2. Net gearing ratio of less than 100%
3. Cash-to-short-term debt ratio of more than 1x

If the developers fail to meet one, two, or all of the ‘three red lines’, regulators would then place limits on the extent to which they can grow debt.  

In September 2020, Evergrande faced a liquidity scare with investors unsure whether Evergrande would be able to honour repayment obligations. Evergrande informed the local government of its financial insecurity, and by leveraging their key position in the real estate sector, convinced material suppliers to waive their right to be repaid to hopefully ensure that Evergrande survived.

Evergrande later denied sending a letter to the Guangdong government in which it warned of a liquidity crisis. In March 2021, the company outlined a plan to cut its debt, but just months later, concerns over the company’s financial health resurfaced, sending some of its bond prices to record lows and its credit ratings were repeatedly downgraded.

Over 1.5 million home buyers have partly paid for Evergrande properties, but those apartments are not yet built. In September 2021, over 100 homebuyers in Guangzhou staged a protest, demanding that the company restart the halted construction work. Missed payments on 40 billion yuan of wealth products sold by Evergrande to retail investors also sparked nationwide demonstrations. Protests like these put pressure on Beijing to intervene and avoid further unrest. Chinese regulators summoned Hui and rebuked Evergrande for its debt problems.

After holding out for months and meeting debt obligations at the last minute, Evergrande finally defaulted in December and finally admitted to the need for debt restructuring. The authorities have intervened and will assist with the process – which will be one of the largest debt restructurings in history. There will be many headwinds ahead; for example, asset management firm Oaktree Capital have seized 2 valuable assets that may hinder the current restructuring.

Potential solution?

HNA, the other debt-ridden Chinese conglomerate, might offer a potential roadmap Evergrande might take. Local government in Hainan, where HNA was based, essentially took control of the company, sold its assets, paid off some of its debt, and is still working on the rest. The Guangdong government now has sent a team to go in at Evergrande and help manage this crisis. Some people think that the government may ultimately take control of the company.