How Evergrande realized he was on the other side of the Chinese regulatory agency

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A high-rise condominium under construction for China Ever Grande Group in Taicang, Jiangsu Province, China, on Friday, September 24, 2021.

Kilai Shen | Bloomberg | Getty Images

BEIJING — Chinese developer Evergrande has made little progress in responding to Beijing’s real estate loan crackdown — too late for investors who have now invested at least $19 billion in offshore bonds. To.

Concerns over the ability of big developers to repay their debt and their total debt of $300 billion are plaguing investors across the world. Beyond the company, there are concerns about potential spillover effects on other real estate industries and economies in China.

A closer look at Evergrande reveals that China’s real estate sector has many of the same problems as other companies, but responds quickly to government regulations aimed at solving those problems. could not do.

Evergrande has missed several payment deadlines since September, the latest being October 11, in which interest has been paid on a US dollar-denominated bond. According to Reuters, it has brought that total missed payments from last month to $279 million.

Analysts say developers have been in debt for years, but problems have arisen only recently after the last two years of stringent regulations.

China’s central bank said on Friday that most real estate developers are acting swiftly, describing Evergrande as a “blind” diversified and expanding unique case. There were some indications that a full-scale rescue plan was underway.

Here’s how the world’s most indebted real estate developer got into such a dire situation:

Evergrande crosses all three red lines

Chinese officials met with 12 real estate developers in August 2020 and requested them to reduce their reliance on debt. According to state media, Evergrande was one of the people attending the conference.

The report explained the unofficially announced “three red line” policy. State media describes the “red line” as three specific balance sheet conditions that developers must meet if they want to take out more debt. This rule requires developers to limit their debt in relation to the company’s cash flow, asset and capital levels.

Julian Evans Pritchard, senior China economist at Capital Economics, said all 12 developers attending the conference crossed at least one red line last summer.

The problem facing the entire industry is that the entire model is heavily dependent on finance.

Zhang Ying Temple

Senior Fellow, ICR

A year later, Evans Pritchard said in a September 22 report that only Ivan Grande and Greenland crossed at least one red line in the original dozen. By the end of June, he said Greenland had more than one and that Evergrande had broken all three red lines.

In contrast, “in the top 30″ [developers]Less than a third is over the limit, compared to more than two-thirds a year ago,” he said.

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

“The problem the industry is facing is that the whole model is too financially dependent,” said Zhang Yingjie, senior fellow at the China Real Estate Institute, ICR.

He said that securing affordable housing will be an important part of China’s economic development plan for the next five years, so there will be restrictions on how quickly developers can expand.

According to official figures from China and the United States, the average price of homes (usually apartments) in China more than quadrupled between 2001 and 2019, while the average price of new homes in the United States rose 80% at the same time. did.

Even when Beijing began promoting the slogan “housing is for living, not speculating” in 2016, prices soared. Many compared the bubble to an attempt to control the real estate market.

Evergrande’s US Dollar External Debt

But over the next few years, Chinese developers will continue to take on debt, especially in overseas markets.

According to Nomura, the industry value of offshore US dollar bonds grew by 900 billion yuan ($139.75 billion) between 2016 and 2020. This is almost double the increase of RMB 500 billion yuan onshore.

According to Dealogic, Evergrande was a leader in foreign bond issuance, accounting for six out of ten US dollar-denominated offshore bond transactions conducted by Chinese real estate companies between 2016 and 2021.

As of the first half of this year, Evergrande held 19% of U.S. dollar-denominated high-yield bonds among Chinese real estate companies, the largest share, at $19.24 billion, according to Natixis. to do.

The next largest foreign bond stocks were Kaisa, Yuzhou, China Fortuneland Development and Guangzhou R&F Properties. All four companies crossed at least one red line, and China Fortune and R&F crossed all three, according to Natixis data analyzed by CNBC.

According to data from Natixis, Hopson Development Holdings, which plans to acquire a share of Evergrande, has not crossed the red line and ranks 28th in terms of asset size.

Hopson declined to comment. Evergrande did not respond to CNBC’s request for comment.

Too much reliance on presales

Like many developers in China, Evergrande sold apartments to individual consumers prior to the completion of the property. This allowed the company to generate cash while taking out loans to develop real estate.

Over the past decade, the value of Evergrande’s real estate under construction has risen so rapidly that it far exceeds the value of the projects the company has completed and what the company can sell.

As of 2020, Evergrande was building a project worth 1.26 trillion yuan ($195.89 billion). However, it was 723.2 billion yuan, which was about 70% of the assets the company sold that year. The actual completed project is only 148.47 billion yuan.

The value of real estate under development accounted for more than half of Evergrande’s total assets, rising from 54.3% at the end of last year to 54.7% in the first half of this year.

With the launch of new regulations affecting Evergrande’s ability to raise funds, it has become impossible to keep up with such a high proportion of construction projects.

“Financial institutions have already reduced their direct investments in the Evergrande Group over the past two years,” a Moody’s analyst said in a memo on October 11.

Lending from banks, trust companies and other financial companies fell sharply from 604.7 billion yuan at the end of 2019 to 393.9 billion yuan at the end of June.

Many of Evergrande’s projects are in China’s smaller cities, where economists say their supply is greater than in China’s largest cities, which have a housing shortage.

Analysts at S&P Global Ratings said in a note on September 20 that suppliers are in a more difficult position than other developers because of their heavy use of commercial invoicing (transactional contracts between payment suppliers and construction contractors). Said there is.

The report said Evergrande’s contract sales declined more than other publishers in the beleaguered region.

According to S&P, it is difficult to maintain other assets that can be created or sold without sufficient funds. “This will prevent contract sales of real estate projects, which are Evergrande’s most important source of cash flow.”

How Evergrande realized he was on the other side of the Chinese regulatory agency

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