Unravelling Evergrande: the Chaotic Collapse of China’s Property Behemoth
Photo Credit: Aly Song/Reuters VIA The Guardian
On Jan. 29, the Hong Kong court ordered the liquidation of Evergrande Group, China's once-dominant real estate titan. With debts totaling over $300 billion USD, Evergrande's downfall has been years in the making — fueled by a combination of unregulated borrowing and stringent regulatory crackdowns on the real estate sector by the Chinese government. This development has since raised concerns regarding the future of China's economy and the ripple effects it will have globally.
The Evergrande Group was established as a private real estate developer in 1996. At the time, China was in a period of rapid urbanisation, and the government was dismantling its system of state-provided housing by privatising urban housing. The company raised over 720 million USD in an Initial Private Offering (IPO) through the Hong Kong Stock Exchange (HKSE) after a decade of its establishment. It was ranked the world’s most valuable real estate brand in 2018 according to NPR. Evergrande made its debut as a Fortune Global 500 company in 2016 and managed to stay on the list until 2022.
In August 2020, the Chinese government introduced the “three red lines”, which are financial regulatory guidelines restricting developers’ ratios of net debt to equity, liabilities to assets of under 70 per cent, and cash to short-term debt of at least 1. As reported by The Economist, this crackdown on the real estate sector alongside the country’s zero Covid policy were the two catalysts for the housing collapse.
In December 2021, Evergrande was labelled “restricted default” by the US Credit Rating Agency after missing two dollar-denominated bond interest payments. The main problem stemmed from over-leveraged borrowing and its overreliance on pre-sales of properties. By selling homes before they were even built, Evergrande was able to repay its debts and continue the cycle of borrowing. However, as the Chinese government implemented stricter regulations on the real estate sector and tightened credit conditions, Evergrande found itself unable to sell enough properties to meet its financial obligations.
The company's financial troubles were also compounded by its complex corporate structure, which included several subsidiaries and off-balance entities. This non-transparency made it difficult for both investors and regulators to audit the true extent of Evergrande's liabilities. This exposed the company to allegations of financial mismanagement and fraud.
There were also reports of Evergrande's subsidiaries encouraging staff to buy financial products from the group’s wealth-management unit, which in turn assisted fund property development, according to employee statements and documents. It was also revealed that some employees were asked to spend up to half their salaries on such products. This raised concerns about the company's malpractice and ponzi-like schemes.
The stock has since plummeted over 93 per cent from its all-time high of $4.05 USD. With Evergrande's collapse, a domino effect has ensued across China's real estate sector. Roughly 40 per cent of Chinese home sales are now linked to other property development companies that have defaulted since mid-2021, according to JPMorgan. With housing assets contributing an average share of 74 per cent to the total household wealth in China, investors who have entrusted their savings to both properties and property-linked wealth management products are facing the consequences of total losses.
In August 2023, Evergrande filed for Chapter 15 bankruptcy protection in the US bankruptcy court of the Southern District of New York in an attempt to restructure its foreign-held debt obligations. Eddie Middleton and Tiffany Wong, the appointed restructuring specialists from Alvarez & Marsal Management Consulting overseeing Evergrande's liquidation, have initiated discussions with multiple law firms regarding the possibility of suing PwC, the auditing giant that served as Evergrande's auditor since the company's listing in 2009. PwC is one of the “Big Four” accounting firms, alongside KPMG, Ernst & Young, and Deloitte. They oversaw its financial reporting during a period of rapid expansion and leveraging in China's booming real estate market. The firm resigned from its role in 2021 due to mounting concerns and challenges faced by Evergrande.
A recent statement from Alvarez & Marsal revealed that the primary priority is ensuring that as much of the business as possible is retained, restructured, and operational. “We will pursue a structured approach to preserve and return value to the creditors and other stakeholders,” Wong said. “That includes considering any viable restructuring proposals,” she added.