How Evergrande found itself on the wrong side of Chinese regulators

Read Time:6 Minute, 43 Second

On Friday, September 24, 2021, the high-rise apartment building of the Binjiang Palace development project under construction by Evergrande Group in Taicang City, Jiangsu Province, China.

Seven Gods | Bloomberg | Getty Images

Beijing-Chinese developer Evergrande has made little progress in complying with Beijing’s crackdown on real estate debt-until it is too late for investors to put money into its offshore bonds, and the company’s offshore bonds are currently worth at least 19 billion US dollars.

Concerns about the giant developer’s ability to repay debt and a total of $300 billion in debt have made global investors uneasy. In addition to the company itself, there are also people who worry that it may affect other real estate industries or the economy in China.

A closer look at Evergrande revealed that this company has many of the same problems as other companies in the Chinese real estate industry, but it did not respond quickly to government regulations aimed at solving these problems.

Ever since September, Evergrande has repeatedly failed to pay on time, the most recent one occurred on October 11, because of the interest owed on one of its U.S. dollar-denominated bonds. According to Reuters, since last month, this has resulted in its total outstanding payments reaching US$279 million.

Analysts said that although the developer has been in debt for many years, its latest problem has indeed emerged after the tightening of supervision over the past two years.

The People’s Bank of China said on Friday that most real estate developers have stable operations and called Evergrande a unique case of the company’s “blind” diversification and expansion. There are few signs that a comprehensive rescue plan is underway.

Here is how the world’s most indebted real estate developer got into such a terrible dilemma:

Evergrande crosses three red lines

The Chinese authorities met with 12 real estate developers in August 2020 and asked them to reduce their dependence on debt. According to official media, Evergrande also participated in the meeting.

The report describes the “three red lines” policy, but it has not yet been officially announced. The official media described the “red line” as three specific balance sheet conditions that developers must meet if they want to take on more debt. The rule requires developers to limit debt related to the company’s cash flow, assets, and capital levels.

Capital Macros senior China economist Julian Evans-Pritchard (Julian Evans-Pritchard) said that last summer, all 12 developers participating in the conference crossed at least one red line.

The problem facing the entire industry is that the entire model is too dependent on finance.

Zhang Yingji

Senior Researcher, ICR

Evans-Pritchard (Evans-Pritchard) stated in a report on September 22 that, a year later, Evergrande and Greenland were the only companies among the original dozen companies that still crossed at least one red line. . As of the end of June, he said that Greenland had crossed one red line, while Evergrande had broken all three red lines.

In contrast, “in the top 30 [developers], Less than one-third exceeds any limit, compared to more than two-thirds a year ago,” he said. “Even companies that do not formally follow the rules generally comply. “

Evergrande warned investors of default at the end of August. Just a few days ago, the People’s Bank of China and other authorities told the company’s executives in a rare meeting to resolve their debt problems.

“The problem facing the entire industry is that the entire model is too dependent on finance,” said Zhang Yingji, a senior researcher at ICR, China Real Estate Research Institute.

He said that since ensuring affordable housing is an important part of China’s economic development plan for the next five years, it limits the expansion speed of developers.

According to official data from China and the United States, between 2001 and 2019, the average price of Chinese houses (usually apartments) more than quadrupled, while the average price of new houses in the United States increased by 80% over the same period.

Although Beijing began to promote the slogan “Houses are for living, not for speculation” in 2016, housing prices have soared. This is an effort to control the real estate market, and many people compare it to a bubble.

Evergrande’s U.S. Dollar Overseas Debt

However, in the next few years, Chinese developers continued to take on debt, especially in overseas markets.

According to Nomura Securities, between 2016 and 2020, the value of offshore USD bonds in the industry increased by 900 billion yuan ($139.75 billion)—almost twice the increase of 500 billion yuan in onshore renminbi bonds.

According to Dealogic’s data, Evergrande is the leader in overseas bond issuance so far. Among the 10 largest offshore USD-denominated bond transactions conducted by Chinese real estate companies from 2016 to 2021, 6 of them came from Evergrande.

According to data from the French Foreign Trade Bank, as of the first half of this year, Evergrande held 19% of US dollar-denominated high-yield bonds among Chinese real estate companies, accounting for the largest share, valued at US$19.24 billion.

The data shows that the share of overseas bonds is followed by Kaisa, Yuzhou, China Fortune and Guangzhou R&F Properties. According to Natixis data analyzed by CNBC, these four companies have crossed at least one red line, and China Fortune and R&F have both crossed three red lines.

Natixis’ data shows that Hopson Development Holdings, which is reported to acquire a majority of Heng’s shares, has not crossed any red line, ranking 28th in terms of asset size.

Hopson declined to comment. Evergrande did not respond to CNBC’s request for comment.

Rely heavily on pre-sales

Like many developers in China, Evergrande sold apartments to individual consumers before the building was completed. This allows the company to generate cash while obtaining loans to develop the property.

In the past ten years, the value of Evergrande’s properties under construction has grown so fast, far exceeding the value of the company’s completed projects and the value of the company’s ability to sell.

By 2020, Evergrande’s projects under construction are worth 1.26 trillion yuan (US$195.89 billion). But this is about 70% more than the real estate the company was able to sell (723.2 billion yuan) that year. The actual completed project is only about 148.47 billion yuan.

The value of properties under construction accounted for slightly more than half of Evergrande’s total assets, rising to 54.7% in the first half of this year, up from 54.3% at the end of last year.

Once the new regulations take effect and affect Evergrande’s financing capabilities, keeping up with such a high proportion of construction projects becomes unsustainable.

“In the past two years, financial institutions have reduced their direct exposure to Evergrande,” Moody’s analysts said in a report on October 11.

They stated that the company’s borrowings from banks, trust companies and other financial companies dropped sharply from 604.7 billion yuan at the end of 2019 to 393.9 billion yuan at the end of June.

Many of Evergrande’s projects are located in smaller cities in China, where economists say there is an oversupply of housing, while there is a housing shortage in China’s largest cities.

Read more about China from CNBC Pro

Standard & Poor’s Global Ratings analysts stated in a report on September 20 that the company’s situation is also more difficult than other developers because it uses a large number of supplier commercial papers-used to pay suppliers and construction contractors. Tradeable contracts.

The report said: “Hengda’s contract sales have fallen more than other issuers in the industry that have experienced difficulties.”

Standard & Poor’s stated that without sufficient financing, it will be difficult to maintain buildings and other assets that can be sold. “This is closing Evergrande’s most important source of cash flow: contract sales of its real estate projects.”

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