How Evergrand found itself on the wrong side of the Chinese regulators

High-rise apartment building at Riverside Palace Development under construction by China Evergrand Group in Taiqang, Jiangsu Province, China, Friday, September 24, 2021.

Kilai Shen | Bloomberg | Getty Images

BEIJING – Chinese developer Evergrande has made little progress in complying with Beijing’s crackdown on real estate debt – until investors poured money into its offshore bonds, now it’s too late for investors worth at least 19 19 billion.

Concerns over the huge developer’s ability to repay debt and total liability of billion 1 billion have pushed investors around the world to the brink. Outside of the company itself, there are concerns about the potential spread to the rest of China’s real estate industry or economy.

A closer look at Evergrand reveals that the company has one of the same problems as others in the Chinese property sector, but has not acted quickly to respond to government regulations aimed at resolving those problems.

Evergrand has failed to meet several payment deadlines since September, and the latest was on October 11 for interest on one of its US dollar-denominated bonds. According to Reuters, it has brought its total missed payments to $ 279 million since last month.

Although the developer has been in debt for years, its latest problems have really come after years of tight control, analysts said.

China’s central bank said Friday that most real estate developers have stable activities and called Evergrand a unique case where the company has “blindly” diversified and expanded. There was little hint on the way to a full rescue plan.

Here’s how the world’s worst-affected property developer is in such dire straits:

Evergrand crosses three red lines

Chinese authorities met with 12 real estate developers in August 2020 and asked them to reduce their reliance on debt. According to state media, Evergrand was among those present at the meeting.

The report described a “three red line” policy, which has not been officially announced. The state media describes the “red lines” that developers must meet three specific balance sheet conditions if they want to take out more debt. The rules force developers to limit their debt in terms of the company’s cash flow, assets and capital level.

Last summer, 12 of the developers at the meeting crossed at least one red line, said Julian Evans-Pritchard, a senior Chinese economist at Capital Economics.

The problem that this whole industry faces is that the whole model depends too much on money.

Zhang Ingji

Senior Fellow, ICR

A year later, Evergrande and Greenland were the only companies in the original dozen that still crossed at least one red line, Evans-Pritchard said in a Sept. 22 report. By the end of June, he said, Greenland had crossed one, and Evergrand had crossed three red lines.

In contrast, “in the top 30 [developers]Less than one-third crossed the line two-thirds a year ago, “he said.” Even companies that are not officially subject to the rules generally comply. “

Evergrand warned investors in late August against default. Just a few days ago, China’s central bank and other authorities held a rare meeting of company executives to resolve their debt problems.

“The problem that this whole industry is facing is that the whole model is very much dependent on money,” said Zhang Yingji, a senior fellow at the ICR, a Chinese real estate research institute.

He said the ban comes on how fast developers can expand because ensuring affordable housing is a key part of China’s economic development plan for the next five years.

The average price of a residential home in China – typically an apartment – more than quadrupled between 2001 and 2019, when a new home in the United States grew 80% at the same time, according to official data from China and the United States.

Even though Beijing started in Beijing in 2001, prices continued to rise when the slogan was spread that “houses are for living, not guessing.” It was an attempt to control a property market that many compared to a bubble.

Evergrand’s US dollar debt abroad

However, over the next few years, Chinese developers began to take out loans, especially in foreign markets.

Between 2016 and 2020, the industry value of offshore US dollar bonds increased by 900 billion yuan ($ 139.75 billion) – almost double the increase of 500 billion yuan in offshore yuan bonds.

Evergrande has so far topped the list of foreign debt issues, accounting for six of the 10 largest offshore US dollar-denominated bond agreements between Chinese and real estate companies between 2001 and 2021.

In the first half of this year, 19% of Chinese real estate companies in Evergrande had high-yield bonds worth মার্কিন 19.24 billion, valued at .2 19.24 billion, according to Natixis.

The foreign bond shares were followed by Kaisa, Yuju, China Fortune Land Development and Guangzhou R&F Properties. These four companies have crossed at least one red line, including China Fortune and R&F, according to data from Natixis analyzed by CNBC.

Hapson Development Holdings, which is set to acquire part of Evergrand, did not cross any red line and is ranked 28th in terms of assets, according to Natixis data.

Hopson declined to comment. Evergrand did not respond to a CNBC request for comment.

Heavy reliance on pre-sale

Like many developers in China, Evergrand sold apartments to individual consumers before the properties were completed. This allows the company to generate cash, while taking loans to develop assets.

Over the past decade, the value of Evergrand’s property under construction has grown so rapidly that it is much higher than the value of the company’s finished projects and what the company was able to sell.

By 2020, Evergrand had projects under construction worth 1.2 tr trillion yuan (195 1955.8 billion). But at 2.2 billion yuan a year, the company sold 70% more assets than it did that year. Only 148.47 billion yuan project has been implemented.

The value of assets under development is just over half of Evergrand’s total assets, which rose to 54.7% in the first half of this year from 54.3% at the end of last year.

Maintaining such a high proportion of construction projects became unstable after the introduction of new regulations and affecting Evergrand’s ability to obtain funding.

“Financial institutions have already reduced their direct exposures to Evergrand over the past two years,” Moody’s analysts said in an Oct. 11 note.

They said the company’s ingots from banks, trust companies and other financial institutions fell to 393.9 billion yuan at the end of June, down sharply from 604.7 billion yuan at the end of 2019.

Many of Evergrand’s projects are in smaller cities in China, where economists say there is more housing than in the largest cities in China where there is a shortage of housing.

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In a Sept. 20 note, S&P Global Rating analysts said the company is in a tougher position than other developers due to the widespread use of commercial contracts – supplier commercial bills – to pay suppliers and construction contractors.

“Evergrand’s contract sales have declined more than other issuers in the sector who have had problems,” the report said.

Without adequate funding, it is difficult to hold on to construction and other assets that can be sold, S&P said. “This is shutting down Evergrand’s most important source of cash flow: the contractual sale of its property projects.”

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