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Evergrande on brink of collapse: 4 things to know

Written by Nikkei Asia Published on     4 mins read

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Indebted developer’s fate poses broad economic and political consequences.

China Evergrande Group’s debt problems are shaking up financial markets in the US, Europe, and Japan. But how has the company reached this point, and what kind of future does it have? Here are four things to know about the world’s most indebted property developer.

What is Evergrande, and what are founder Xu Jiayin’s political connections?

One of China’s leading property developers, Evergrande, was established in 1996 in the southern city of Guangzhou. What started out as a tiny operation with fewer than a dozen employees established a foothold with small, affordable condominiums, and rode a real estate boom in the 2000s.

The company booked RMB 507.2 billion (USD 78.4 billion) in revenue last year, and ranked second in the country by floor area sold.

Founder and chairman Xu Jiayin—known as Hui Ka Yan in Cantonese—was involved in setting up a real estate business at a trading house in the 1990s, and found considerable success with middle-class housing. Xu used this know-how to launch Evergrande, where he set internal rules on property designs and material purchases to keep costs down.

Xu led Hurun Report’s 2017 list of the richest people in China, with RMB 290 billion in assets. In 2018, he was recognized by the Chinese Communist Party as one of 100 outstanding private entrepreneurs for the 40th anniversary of the “reform and opening-up” policy.

As his star rose in the business world, Xu was tapped to join the Chinese People’s Political Consultative Conference, a top advisory body, and gravitated toward politics. He has actively contributed to China’s anti-poverty drive and other state initiatives, and invested in regional industry and education, building connections with political heavyweights in the process.

Following his success in real estate, Xu has made forays into a variety of fields. Evergrande owns the soccer team Guangzhou FC, a two-time winner of the AFC Champions League, and has promoted volleyball and other sports. The company’s business interests now range from theme parks to electric vehicles.

But ballooning debt has put Evergrande’s finances on shaky ground.

Why is Evergrande in trouble?

In the summer of 2020, the People’s Bank of China drafted “three red lines” for property developers: a maximum debt-to-asset ratio of 70%, a 100% cap on net debt to equity ratio, and cash at least equal to short-term borrowing. Companies that fail to meet these requirements face restrictions on borrowing from banks.

Evergrande scrambled to fix its finances to meet these stipulations. It has discounted condominiums to sell them faster and bring in cash, pushing down the average price of its properties 14% on the year to RMB 8,055 per sq. meter this past July.

While it managed to pay down some debt, improvement remains slow. Evergrande still failed to meet two of the red lines at the end of June, according to the Beike Research Institute.

Construction companies and suppliers that do business with Evergrande have spoken up about late payments—a change from the usual power balance in the industry in which developers typically hold all the cards. A regional bank froze deposits held by Evergrande, apparently over problems with a loan.

Why did Evergrande’s troubles hit global stock markets so hard?

The scale of its liabilities, the impact on foreign investors through the company’s USD 20 billion in foreign debt, and the view that the situation poses another test for President Xi Jinping’s policies all played a role.

Amid growing signs of trouble, Evergrande issued a statement September 13 saying it faced “unprecedented difficulties.” While it denied rumors of looming bankruptcy, the acknowledgment of the severity of the situation fueled alarm over Evergrande-related risks.

The company’s liabilities total RMB 1.97 trillion yuan—equivalent to 2% of China’s nominal gross domestic product. Mishandling the situation could have serious consequences for the country’s financial system.

Attention has shifted to whether Evergrande will default on a number of debt payments coming due late this month and beyond.

Interest in its fate extends beyond the financial world. A further cash crunch could affect construction of condominiums that have already been purchased by consumers, which would be especially problematic in a country where housing makes up the bulk of many people’s wealth.

Will Evergrande go bankrupt?

If it cannot turn itself around, bankruptcy restructuring is one option. If creditors agree, they would take a haircut on the debt while the company worked to get back on its feet. HNA Group began this process in February.

But going this route would bring no guarantee of a successful restructuring. If Evergrande continued to founder, it could be liquidated.

One major unanswered question is whether the government would step in to save the company.

Hu Xijin, editor-in-chief of the Communist Party-affiliated Global Times, said on social media that Evergrande should not count on a bailout and that at a time when the government is making changes to the industry, it will not protect companies no matter how serious their problems.

As Xi has ratcheted up his campaign for “common prosperity,” the real estate industry has been targeted with new regulations to address soaring housing prices, seen as a root cause of rising inequality. Rescuing Evergrande would muddy Beijing’s message, but the government also cannot afford to underestimate the impact of a collapse on China’s economy and society.

Read more: 5 takeaways from MetaProp’s latest deep dive on proptech in China

This article first appeared on Nikkei Asia. It’s republished here as part of 36Kr’s ongoing partnership with Nikkei.

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