A Breakdown of the Evergrande Debt Crisis

Evergrande, which was once an illustrious Fortune Global 500 company, is now the world’s most-indebted real estate developer. 

The company has been on all over news headlines in recent weeks for its massive $304 billion debt. That is HUGE considering the whole state of Russia’s debt stood at $257 billion in 2021. 

You must be wondering, how did they get into so much debt?

This story is fascinating and carries a lot of learning about finance and business so I wanted to dig deeper into the situation with all of you curious folks. Here’s a breakdown on the business, background and its very public fall from grace. 

The background

Evergrande, formerly known as the Hengda Group, was founded by businessman Hui Ka Yan in 1996 in Guangzhou, Southern China. At its core, it’s a homebuilder business – scaling up over time from a small local player into a national behemoth. 

Evergrande Real Estate currently owns over 1,300 projects in 280+ cities across China. However, the broader Evergrande Group encompasses far more than just real estate development. Its businesses range from wealth management (Evergrande Wealth), internet and media production (HengTen Networks), electric cars manufacturing (Evergrande New Energy Auto), mineral water and food (Evergrande Spring). It even owns one of the country’s biggest football teams – Guangzhou FC AND a theme park (Evergrande Fairyland). 

The Business Challenge

We all know that building a new development project takes many months (even years) and requires a lot of cash outflows along the way. Revenue typically doesn't come in until the project is completed. 

So how did Evergrande finance its impressive growth? Debt. The property developer has financed its various pursuits by borrowing money to the tune of $304bn. It has not only borrowed from banks, trust firms and bondholders, but also from its employees and wider society.  

"Strayed far from its core business, which is part of how it got into this mess," said Mattie Bekink, China director of the Economist Intelligence Unit.

Too ambitious for its own good, Evergrande sold many homes before they were even completed. By the end of 2020, the property developer had more than 700 unfinished projects and 1.6 million people waiting to move into their new homes. 

Its debts grew alongside its size and assets. Evergrande has been borrowing aggressively and not exercising restraint for years; bidding land at prices significantly higher than market, in the knowledge that the risk would be passed onto banks or other financial institutions financing the purchases. All the while, they have been racking up obligations with building suppliers and people who purchased off-the-plan apartments. 

It’s alluring: continue to borrow money to make your payments and you’ll be kept safe by the government. As the second biggest property developer in the country, if it went under, it would bring the entire economy down with it. 

Hefty bills to pay

The property developer has landed in hot water since the commencement of China’s  “Three Red Lines” policy in August 2020 – a trio of metrics that policymakers use to control the amount owed by real estate companies. Failure to meet these metrics means no access to new bank loans. 

Evergrande could no longer take on more debt, forcing it to sell properties at major discounts nationwide and some of its sprawling business empire. 

Despite the company’s effort, its apartments are not selling fast enough to meet its debt repayments. 

Its share price tumbled by more than 80% this year. Credit rating agencies have also downgraded its bonds. 

Why do we care if Evergrande fails?

Firstly, many people who bought properties from Evergrande off plan could potentially lose their deposits if the firm collapses. Global investors who are owed $7.4 billion in bond payments from Evergrande next year could see their money vanish into thin air.  

Secondly, companies that do business with Evergrande from construction and design firms to materials suppliers are at risk of incurring major losses which could force them into bankruptcy. 

Thirdly, Evergrande owes money to around 171 domestic banks and 121 other financial firms. If it defaults, banks and other lenders may be forced to lend less, resulting in a credit crunch, meaning other companies would struggle to borrow money at affordable rates. 

It’s consequential not only to the Chinese economy but to other emerging markets too. Given that China is Australia’s largest trading partner, the Evergrande crisis has potential spillover effect on Australian economy in 3 key ways: Lower demand for iron ore; Lower demand for other goods and services that Australia provides; Investors starting to lose confidence, wondering which companies are living on borrowed money and time right now. 

What happens next?

China is caught in a very tough spot: act quickly with a bailout and be viewed as condoning bad corporate debt; OR fail to act and allow the fallout to ripple through the wider economy that is just recovering from COVID-19.

Analysts believe there will be some supporting measures from the central government or even the central bank to bail out Evergrande. 

Many people will be hoping the company will be able to meet its liabilities. The key here is to get project construction going and sell inventory. If these steps are insufficient, Evergrande will need some type of government support to avoid a collapse.