Evergrande Group has been a topic of discussion for global news channels for months as China’s most indebted property player. Founded on June 26, 2006, Evergrande Group is an investment holding company involved in investment, development, and real estate properties management, with its headquarters located in Shenzhen. The company is currently struggling under the liability of $300 billion, including $20 billion of offshore bonds after cross-default concluded by rating agencies due to its missed interest payments. The expansion strategy for the company has been borrowing millions of cash from banks and its investors and pre-selling its unfinished apartments. The aim was to acquire more and more land and develop more mass projects in almost 200 cities of China. In September 2021, it had almost 800 projects due while its Hong Kong stock exchange shares lost approximately 80% of their value.
These debt issues were enhanced with the company when property sales constantly fell in China due to the pandemic and when the Chinese government implemented guidelines to control the speculation in the property market. In the first three months of 2020, when Covid-19 was at its peak, the real estate market hit the lowest but jumped back to 7.1% growth in April-June. After that, the market was recovering but controlling rising real estate prices; the Chinese government strengthened regulation and supervision of the real estate market to bring home prices to an affordable range. According to estimated data, experts stated that around 90% of Chinese households own one apartment already, while one out of four apartments in China was currently empty. This supported the claim that the property market encouraged expansion based on speculation instead of actual demand.
The three red lines policy
The property prices have increased sixfold in the last 15 years, making homes in big Chinese cities like Shenzhen even more expensive than London. The New rules drafted for the real estate market were announced in August 2020 by The People’s Bank of China and the Ministry of Housing to control this surge. This move justified China’s paramount leader’s words – “housing is for living in, not for speculation”.The state-owned media outlets famously called the new rules ‘three red lines,’ which will place caps on debt ratios on borrowed money. These were aimed to reduce property developers’ leverage, improve debt coverage, and increase liquidity in the sector for better scrutiny.
Under these guidelines, the property developers have to take into consideration three rules while borrowing funds –
- 70% ceiling on liabilities to assets, excluding advance proceeds from projects sold on contract. The percentage of assets funded by debt should not be more than 70%. The more liabilities to assets ratio is, the more financial risk a company holds.
- A Net Gearing Ratio of less than 100% – Gearing ratio measures how much a company is funded by debt to its financing by equity. A higher gearing ratio to 100% would mean the company has a larger proportion of debt versus equity or capital.
- Cash to short-term debt ratio of at least 1- Cash to short-term debt ratio calculates how much time it would take a company to repay its debt if it devoted all of its cash flow (earnings) to debt repayment. So a value of 1 is safe to ensure the company doesn’t end up bankrupt.
If all three criteria are passed (green), the company can increase its debt up to 15%. A breach of one (orange), two (yellow), and three (red) criteria will decrease the percentage to which debt can grow to 10%, 5%, and 0% in the following year, respectively.
The government wished to control the credit environment in the property market, which ultimately led to higher prices forcing them to take out loan interest payments from the consumers. However, experts are worried that China would make the same mistake that Japan did by limiting excessive credit and closing down insolvent borrowers early, leading to long-term economic growth damage. The fear turned into reality when in September 2021, China’s biggest property developer, Evergrande, was unable to meet its interest payments on time, causing cash flow problems. The bonds and stocks of the company collapsed, and investors worldwide went into the fear that it would have an impact on the Chinese economy. After the debt caps guidelines were pressed, developers had only a few ways to make their balance sheets balanced. One of them was to reduce home prices to increase sales and earn some capital. Evergrande adopted the same policy when it offered discounts up to 30%, which were surprisingly its deepest cuts. Other ways included Evergrande selling its equity sales and selling non-property management assets or services. Let’s see how the crises have folded over the span of more than a year.
From beginning to present
The popularly called three red lines policy is introduced to Evergrande and various other policy developers by the regulators in a meeting. Following that, ahead of the property management subsidiary’s initial public offering (IPO), Evergrande sold a $3 billion stake. A Shenzhen backdoor listing for a unit that has been dormant for four years was requested by the company from the government of Guangdong province not to face the cash crunch issue.
The company offered a month-long discount of 30%, which has been the biggest cut to incentivize consumers to increase sales.
Through a secondary shares sale deal, $555 million was raised.
The Shenzhen backdoor listing plan was canceled while some key investors decided not to seek repayment. Hong Kong IPO of Evergrande Property Services Group Ltd. raised $1.8 billion.
Six new investors were brought by China Evergrande New Energy Vehicle Group Ltd, which raised $3.4 billion.
The company sold $2.10 billion worth of shares in their online automobile and real estate marketplace Fangchebao in a pre-IPO deal to 17 investors. It turned several subsidiary units into a new company to raise money and listed Fangchebao early for sale.
The company announced to sell a $386 million share in China Calxon Group Co Ltd. It raised $1.74 billion to pay back interest on dollar bonds and a maturing bond. Out of the three debt caps of the policy, it achieved one by reducing interest-bearing debt from $112.47 billion to $89.47 billion.
At the request of China Guangfa Bank Co Ltd, the court ordered Evergrande to freeze a %20.7 million bank deposit. It claimed that the loan would not be due until March 2022 and intended to pursue legal action. Some Hong Kong banks refused to give additional loans to buyers of Evergrande’s unfinished residential projects.
Evergrande agreed to give up HengTen Networks Group Ltd interests valued at $0.42 billion. According to reports, Evergrande cases are concentrated in the Guangzhou Intermediate People’s Court.
According to state media, construction on two Evergrande projects in Kunming was suspended, one owing to late payments. Hui Ka Yan resigned as Chairman of Hengda Real Estate Group, the company’s flagship unit.
Chairman of company Hui assured customers that Evergrande would finish building their houses. It asked for a deferral on trust-loan interest payments to CITIC Trust and other creditors. Hundreds of investors gathered in the foyer of Evergrande’s Shenzhen offices to demand loan payback.
Evergrande claimed that online rumors of bankruptcy and reorganization were “completely false” but admitted to the “unprecedented problems.” Evergrande claimed to have settled a payoff on an onshore bond but then failed to meet a $131 million payment dated September 23rd and 29th.
The company’s second-largest stakeholder, Chinese Estates Holdings Ltd, announced its intention to sell its shareholding unless it receives a quick cash infusion. Evergrande plans to sell ShengJing Bank Co Ltd shares to raise $1.57 billion.
Some Evergrande dollar bondholders’ advisers, including investment bank Moelis & Co and legal firm Kirkland & Ellis, voiced a need for greater information and openness. Evergrande missed $148 million in principal payments, due on October 11.
Hong Kong’s audit authority has said that it looks into Evergrande’s 2020 accounting and PwC’s audit. According to reports, Evergrande paid a $19.10 million bond coupon. Evergrande scrapped a decision to sell a $2.6 billion stake in its services division to competitor Hopson Development Holdings Ltd. The company remits payments for a dollar bond obligation due September 23 to prevent failure well before the 30-day grace period expires.
Bedeo, a British e-mobility company, has announced the acquisition of Protean Electric from Evergrande’s automotive division. Evergrande avoided a destabilizing default once more by making a last-minute bond payment. Evergrande announced the sale of its whole share in HengTen, a streaming services company, for $274 million.
Evergrande’s electric vehicle subsidiary has announced that it would raise $347 million via a share sale to help fund the development of new-energy vehicles.
A government organization took control of Evergrande’s soccer stadium, intending to sell it. Chairman Hui sold 1.2 billion shares for $344 million, reducing his Shenzhen-based real estate firm ownership from 77% to 67.9%.
When the deadline was missed, the company’s $19 billion in overseas debts shifted into cross-default.
Sales for 2021 fell 39% from the previous year to $69.5 billion, while Evergande’s stock has lost about 90% of its value in the last year, as investors fear the company is on the verge of imploding under the weight of its debts.
Footprints of the crisis
All of this is bad news for China’s economy since property developers in the country are reported to owe more than $5 trillion in debt. It’s a massive burden for the world’s second-largest economy, which is already dealing with issues such as the oil crisis and rising raw-material costs. The property industry accounts for almost 25% of China’s Gross Domestic Product, and Evergrande is its major big player. The Chinese government has instructed local officials to keep the fall of the governing Evergrande Crisis under control. However, the government did little to help Evergrande get out of its predicament. Some investors believe that allowing Evergrande to collapse is a step in the right direction for the government to reduce debt in the economy. However, there is no doubt that Evergrande has ruined the property market and weakened the confidence of both consumers and investors. While Evergrande continues to bleed in uncertainty, it remains whether the Chinese government will bail out the company or leave on its fate.
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