Residential high-rises in the Riverside Palace development under construction by the China Evergrande Group in Taicang, Jiangsu Province, China, on Friday, September 24th, 2021.

Qilai Shen | Bloomberg | Getty Images

BEIJING – Chinese developer Evergrande made little headway into implementing Beijing’s crackdown on real estate debt – until it was too late for investors to pour money into its offshore bonds, which are now worth at least $ 19 billion.

Global investors worried about the giant developer’s ability to repay its debts and $ 300 billion in total debt. Beyond the company itself, there are concerns about a possible spillovers on the rest of the Chinese real estate industry or economy.

A closer look at Evergrande revealed a company with many of the same problems as others in China’s real estate sector, but not as quick to respond to government regulations designed to address those problems.

Evergrande has missed several payment deadlines since September, most recently on October 11 for interest on one of its US dollar-denominated bonds. The total number of missed payments rose to $ 279 million since last month, according to Reuters.

While the developer had been in debt for years, its recent problems really came after tighter regulation over the past two years, analysts said.

China’s central bank said on Friday that most real estate developers are in stable operation, citing Evergrande a unique case in which the company has “blindly” diversified and expanded. There was little evidence that a comprehensive rescue plan was on the way.

This is how the most heavily indebted property developer in the world got into such an emergency:

Evergrande crosses all three red lines

Chinese authorities met with 12 real estate developers in August 2020 and urged them to reduce their reliance on debt. Evergrande was among those attending the meeting, state media said.

The report described a “three red lines” policy that was not officially announced. State media describe the “red lines” as three specific balance sheet conditions that developers must meet in order to take on more debt. The rules require developers to limit their debt in relation to the company’s cash flows, assets, and capital levels.

Last summer, all 12 developers at the meeting crossed at least one of the red lines, said Julian Evans-Pritchard, chief China economist at Capital Economics.

The problem this entire industry is facing is that the whole model is too finance-based.

Zhang Yingji

Senior Fellow, ICR

A year later, Evergrande and Greenland were the only companies of the original dozen that still crossed at least one of the red lines, Evans-Pritchard said in a September 22 report. In late June, he said Greenland crossed one while Evergrande crossed all three red lines.

In contrast, “among the top 30” [developers], Less than a third exceed the limits, compared to over two thirds a year ago, “he said.” Even companies that are not officially subject to the rules have usually adhered to them. “

Evergrande warned investors of a default in late August. Just days earlier, China’s central bank and other authorities in a rare meeting called on the company’s executives to resolve their debt problems.

“The problem that this entire industry is facing is that the whole model is too finance-based,” said Zhang Yingji, senior fellow at China’s ICR real estate research institute.

He said the restrictions on how quickly developers can expand is an important part of China’s economic development plan for the next five years to ensure affordable housing.

The average price of a residential home in China – typically an apartment – more than quadrupled between 2001 and 2019, while the price of a new home in the US rose by 80% over the same period, according to official data from China and the US

The rise in prices even came when Beijing began promoting a slogan in 2016 that is “Homes to Live in, Not to Speculate”. It was an attempt to control a real estate market that many compared to a bubble.

Evergrandes US dollar debt overseas

However, over the next several years, Chinese developers continued to take on debt, particularly in overseas markets.

Between 2016 and 2020, the industry’s offshore US dollar bonds rose by 900 billion yuan ($ 139.75 billion) in value – nearly double the 500 billion yuan growth in onshore yuan bonds, according to Nomura .

Evergrande was by far the leader in foreign bond issuance, accounting for six of the ten largest offshore bond deals by Chinese real estate companies in US dollars between 2016 and 2021.

In the first half of this year, Evergrande held 19% of the US dollar-denominated high-yield bonds of Chinese real estate companies – the largest stake valued at $ 19.24 billion, according to Natixis.

The next bonds overseas were Kaisa, Yuzhou, China Fortune Land Development and Guangzhou R&F Properties, the data showed. All four of these companies have crossed at least one red line, with China Fortune and R&F crossing all three, according to data from Natixis, analyzed by CNBC.

Hopson Development Holdings, which is reportedly set to acquire part of Evergrande, hasn’t crossed any of the red lines and ranks 28th by asset size, data from Natixis showed.

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

Strong dependency on advance sales

Like many property developers in China, Evergrande sold homes to private customers before the properties were completed. This enabled the company to generate cash and at the same time take out loans for the development of the real estate.

Over the past decade, Evergrande’s property under construction has grown so rapidly in value that it has far exceeded the value of the company’s completed projects and what the company was able to sell.

As of 2020, Evergrande had projects valued at 1.26 trillion yuan ($ 195.89 billion) under construction. But that was around 70% more than the real estate the company sold that year, which was 723.2 billion yuan. Only about 148.47 billion yuan in projects were actually completed.

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

Maintaining such a high proportion of construction projects became unsustainable when the new regulation came into force and impaired Evergrande’s financing options.

“Financial institutions have already reduced their direct exposure to Evergrande in the past two years,” Moody’s analysts said in a October 11 release.

They said the company’s borrowing from banks, trust companies, and other financial firms fell to 393.9 billion yuan in late June, down from 604.7 billion yuan in late 2019.

Many of Evergrande’s projects are in smaller Chinese cities, which economists say are oversupplied with housing compared to China’s largest cities, which have a housing shortage.

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The company is also in a tougher position than other developers because of the heavy use of commercial invoices from suppliers – negotiable contracts for paying suppliers and contractors, analysts at S&P Global Ratings said in a September 20 statement.

“Evergrande’s contract sales have declined more than other issuers in the industry that were in distress,” the report said.

Without adequate funding, S&P said it would be more difficult to maintain construction and other realizable assets. “This will shut down Evergrande’s most important source of cash flow: the contractually agreed sale of its real estate projects.”