China Evergrande veers toward default — and a $300 billion global shock

Only two years ago, real estate tycoon Xu Jiayin hovered at the top of China’s rich lists as a model of the country’s swaggering, newfound wealth.

Evergrande, the company he founded in 1996, was among China’s largest developers. The company sold many millions of apartments every year to Chinese middle-class families who wanted to put their savings into a seemingly inexorable housing boom HTML1. He owned a successful soccer club, showed up at high-level political meetings wearing ostentatious designer belts and took his private jet to Paris on a whim.

Now, Xu’s reputation, along with his property empire, is crumbling under more than $300 billion in liabilities. The conglomerate had been building up its debts to finance expansion for years. Authorities were unable to stop the reckless behavior of the financial giant. China’s central bank ordered it to cease its debt addiction earlier in the year.

Evergrande said Sept. 22 that it will make a payment due on a domestic bond calming fears of an imminent default that could unleash financial chaos globally. (Reuters)

The resulting liquidity crisis is widely expected to end in one of China’s largest defaults, in what would be a severe shock for the country’s property market and a blow for the Chinese Communist Party’s campaign to tackle financial risks without harming economic growth or the everyday livelihoods of Chinese households. Global stock markets tanked Monday amid growing panic of wider contagion starting with foreign creditors left without payments.

Fear of widespread fallout from a default leaves Chinese regulators with a dilemma, analysts say. Although they could help creditors, this would encourage bad corporate behaviour and reinforce the assumption that government intervention is possible when the situation becomes too serious. They could also choose to not prevent default, which would risk further financial turmoil and a roiling of markets.

The question is how much pain is the government willing to inflict to teach Evergrande and the sector a lesson, said Travis Lundy, an independent analyst based in Hong Kong. He said that it was always about when and not if real estate growth would stop, as the sector had clearly gotten out of control.

Yet, ending decades of rising property prices will not be a popular decision. How do you poke a hole in a bubble every homeowner, local government, and business owner doesn’t like being pricked?” This is something that nobody wants. Lundy stated that if this happens, it will cause a lot more pain.”

When development stopped on the Evergrande Technology and Tourism City apartment complex in Wuhan, buyers began visiting the abandoned construction site to take photos of their incomplete future homes in a bid to draw official attention on Chinese microblog Weibo.

“A whole family emptied out our wallets to buy this home, and we have a home loan of 6,000 yuan per month,” one buyer wrote in the owners’ group. We don’t want to be sick or take time off from work. . . . All complaints to authorities are passed around as if they were a football. What are we thousands of owners to do?”

So far, the Chinese leadership appears inclined to allow a default. S&P Global Ratings stated in Monday’s note that Beijing would not be obliged to intervene if there was a widespread contagion that caused multiple developers to collapse and poses systemic risk to the economy.

An announcement by Evergrande’s main Hong Kong-listed unit on Wednesday that it would make an interest payment on $36 million of yuan-denominated bonds the next day eased some fears of impending shocks to the global financial system. It has yet to say if it will pay the larger dollar-denominated bonds that are due Thursday or later in this month.

That Beijing is even considering allowing such a large company to go bankrupt, something that would have been unthinkable a decade ago, reflects a shift in government priorities, analysts said.

President Xi Jinping has made tackling financial risks one of three “tough battles” for the party, alongside reducing air pollution and eliminating poverty. Authorities set red lines last year to make real estate developers drastically cut their debt. This signaled a reckoning to highly leveraged businesses like Evergrande.

Evergrande is unlikely to become China’s “Lehman moment,” but the strictness of government policies may create unintended consequences for the property market, said Zhu Ning, a scholar at Shanghai Jiao Tong University and author of “China’s Guaranteed Bubble.”

“Everyone is saying that the credit-tightening policies are too strong and have gone on for too long,” he said. It’s slowing down the economy too much. I worry about growth losing speed much faster than expected.”

Evergrande’s market capitalization has plummeted from nearly $40 billion last year to under $4 billion. The cash crunch has halted construction at dozens of building sites across the country. Last week, angry suppliers and employees swarmed the group’s headquarters in Shenzhen demanding payments.

Evergrande’s operations span hundreds of projects across dozens of cities, making it difficult for the stability-obsessed party to ignore the public outcry. Analysts argue that the regulators will prioritize ensuring home buyers and suppliers don’t go broke; creditors are secondary concerns.

For a Chinese leadership that prides itself on successful stewardship of China’s economy after the 2008 global financial crisis, the comparisons to Wall Street’s Lehman Brothers crisis are especially unwelcome.

“It’s not the same as just letting Lehman go,” said Zhu, adding that the Chinese government takes a fundamentally different approach to the United States, because of the political and social importance of implicit guarantees of wealth.

Throughout the company’s history, Xu has been adept at using Evergrande’s once easy access to capital to enter emerging sectors prioritized by Beijing. The company’s complicated web of businesses, which was once an opportunity for growth, has now become a problem as it struggles to find buyers to buy multiple companies with poor track records.

A health-care unit, which was listed separately in Hong Kong, was rebranded last year as an electric vehicles maker. The automaker-to-be began construction on multiple factories across China and pledged to manufacture 1 million cars by 2025. The automaker-to-be has not yet sold a single vehicle.

In recent weeks, Xu, who stepped down as chairman of Evergrande’s main unit in August, has made a show of taking responsibility for the company’s debt crisis.

The company jet — presumably carrying Xu — flew from Shenzhen to Beijing and back in one day last week, according to data from Flightradar24. Xu, in a Mid-Autumn Festival email to his employees Tuesday, promised that he would end the “dark hours” of the group and finish their apartments. He also said that he would repay all suppliers. Ding Yumei (Xu’s wife) purchased $3 million worth of Evergrande investments products last week.

But some of the company’s efforts to raise cash by asking for loans or encouraging employees to buy wealth management products have only served to sharpen focus on its methods for raising capital off the books.

One lender named Yang Yang who agreed to transfer an Evergrande subsidiary 10 million yuan (about $1.5 million) in July took to social media in frustration after the company failed to make its promised repayment in 10 days.

“Evergrande has all kinds of fundraising channels to avoid oversight,” he said in an interview. They have always paid back, but this is different. It’s totally shameless.”

In response to mounting criticism, online censors have stifled discussion of potential bankruptcy for Evergrande. At least 30 financial blogs were shuttered in early September as part of an effort to “rectify” online discussion.

The potential hit to family incomes from Evergrande’s downfall comes as Xi has preached a gospel of “common prosperity” and launched crackdowns spanning ride hailing to private tutoring in the name of ensuring social stability.

But the ambitious agenda has raised fears that the basket of policies to target a looming demographic crisis and stark inequality could backfire and intensify financial burdens for everyday Chinese households.

One joke widely shared on social media read: “This year’s most tragic household: the husband lost his job as a real estate agent, the wife lost hers in education; they bought an Evergrande house and speculated on Internet stocks, before unexpectedly having a third child.”

Pei Lin Wu in Taipei contributed to this report.

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