The Evergrande debt crisis is the ongoing financial situation of Chinese property developer Evergrande Group. After a letter circulated online of the company informing the Guangdong government that it was at risk of a cash crunch, shares in the company plunged in value, with impacts on global markets and a significant slow-down in foreign investment in China during August and September of 2021.
Thousands of retail investors, as well as banks, suppliers, and foreign investors are owed money by the company. As of 21 September, the developer has 2 trillion RMB (310 billion USD) in liabilities.
Evergrande’s land reserves alone are large enough to house 10 million people. However, Evergrande had pursued an aggressive expansion over the last years, including ventures in electric vehicles, theme parks, energy, and many other sectors.
These leveraged investments included Ocean Flower Island, a 100 billion RMB (15.5 billion USD) project to build an artificial island in the South China Sea, plans to spend over 45 billion RMB (7 billion USD) between 2019 and 2021 in electric vehicle development, and ownership of Guangzhou F.C., China’s richest football club.
Wealth Management Products
On 21 September 2021, Financial Times reported that “Evergrande used retail financial investments to plug funding gaps”. In this scheme, the company raised billions of dollars through wealth management products (WMP), using that money to make up for lacks of funding in the company and re-pay other wealth product investors.
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The products were highly risky, with an anonymous executive suggesting they were “too risky for retail investors and should not have been offered to them”. However, they were marketed widely, with Evergrande managers pressuring subordinates to purchase products advertised at over 10% annual returns. In total, the remaining WMP liabilities stand at 40 billion RMB.
Referred to as a type of supply chain finance, investors would invest money in shell companies they falsely believed to exist to supplement their working capital. As sales in the products fell, the business model of the products became unsustainable.
An Evergrande executive is quoted as saying “Many people . . . might be arrested for financial fraud if investors don’t get paid off. Our products were not for everyone. But our grassroots salespeople didn’t consider this when making their sales pitches and they targeted everyone in order to meet their own sales targets.”
Other Chinese companies have also sold wealth management products, including Baoneng, Country Garden, Sunac, and Kaisa.
Three Red Lines
In an effort to rein in the highly indebted sector, the Chinese government enacted a “three red lines” rule to regulate the leverage taken on by property developers, limiting their borrowing based on their performance in debt-to-cash, debt-to-equity, and debt-to-assets metrics.
Evergrande is considered by analysts to be too big to fail and a Lehman Brothers–style collapse would have massive consequences on the Chinese economy and the world at large.
The new regulations greatly affected the property developer, which had historically leveraged itself heavily. So while the company’s stock price had outpaced the Hang Seng Index thirty-percent growth rate between its 2009 IPO and 2017, having multiplied eightfold, it had also become the world’s most indebted property group.
The Financial Times cited the director of S&P Global Ratings as stating that the developer was “so highly leveraged, it’s likely to breach all of the alleged thresholds”.
The company announced in March 2021 that it was looking to cut its debt load by 150 billion RMB (USD$23.3 billion ‘). Nonetheless, Evergrande was still expanding, having launched 63 new projects in the first half of 2021.
Other central and local government regulations, including mortgage lending limits, rent caps in big cities, and land auction cancellations, precipitated a slowdown in the property sector, as authorities attempt to control rising house prices.
The ‘Fabricated’ Letter
A letter circulated online on the last week of August 2021, where Evergrande informed the government of Guangdong province that they were close to running out of cash.
The company alleges the letter has been fabricated and is “pure defamation”, and followed its circulation by a number of public announcements to reduce fears from investors and the public.
In a statement on 31 August 2021, Evergrande warned it would default on its debts if it failed to raise enough cash to cover them. At the time, Evergrande was China’s most indebted real estate developer.
On 24 September, Evergrande missed off-shore bond payments totalling 83.5 million USD. While the company has 30 days to avoid defaulting on the debt, analysts feel it is unlikely to manage doing so.
In order to raise capital, the group has started to sell off some of its assets. On 29 September 2021, the company sold a 20% stake in Shengjing Bank, retaining 15%, raising 10 billion RMB (1.5 billion USD).
On October 4, 2021, the Cailian Press reported that rival Hopson Development was set to buy a 51% stake in the Evergrande Property Services subsidiary for around US$5 billion.
Corporate Bonds Exposure
American and European companies had significant exposure to Evergrande through their holding of corporate bonds. Ashmore Group, an emerging market specialist, owned more than $400 million at the end of June while UBS itself owned over $300 million.
Other companies such as BlackRock held much less, with the world’s largest asset manager holding just over $18 million, and HSBC having a peak exposure of $31 million.
On 28 September 2021, Sunac bought back $34 million of its bonds and denied requesting government assistance. A letter, which the developer claimed was merely a draft, surfaced online arguing that recent regulations in Shaoxing intended to control property prices had left a local project unable to break even.
On 5 October 2021, developer Fantasia Holdings missed a payment on a USD$206 million bond that had matured the day before, triggering a default. Just weeks prior, the developer had assured investors it had “no liquidity issue”.
On 22 September 2021, the governments in Zhuhai and Nanshan District, Shenzhen took control of sales revenue for Evergrande’s properties in a state-controlled custodial account to protect home-buyers and continue construction of the company’s developments.
Various provinces have been doing so since August as the developer has put hundreds of these projects on hold.
Off-shore bondholders hired Kirkland & Ellis and Moelis & Company to advise them ahead of a potential restructuring, according to the Financial Times.