The Problems of Evergrande: A 2021 Lehman Brothers?
By Brendan Connelly | October 21, 2021
Chinese real estate company Evergrande has faced a tumultuous 2021, with its problems reaching a boiling point this summer. Evergrande, a company founded in 1996 by Hu Ka Yan, is one of the largest real estate developers in China, which has ridden on the back of rapid Chinese real estate growth over the past two decades. Ranked 122nd on the global Fortune 500, Evergrande currently employs more than 200,000 people and owns more than 1,300 real estate projects in 280 Chinese cities. But its business ventures do not stop there. Evergrande also invests in electric cars, theme parks, food, and beverage companies and even has its own soccer team, building one of the largest soccer schools in the world, along with a team stadium currently in construction. However, in pursuing these various ventures, Evergrande has run into some issues. The company is currently $300 billion in debt, making it the world’s most indebted developer. To note some other complications, the company has also administered $6.5 billion in wealth management assets, as well as over one million flats that have been pre-paid for by homeowners that have not finished construction. Recently, Evergrande informed investors of possibly defaulting on its debt and that it was having trouble finding investors for their assets.
The catalyst for Evergrande’s problem can be seen from recent restrictions from the Chinese government on the amount real estate developers are able to borrow. This was done in an attempt to teach a lesson to companies that had borrowed excessively to finance property construction and other business ventures. A noteworthy example can be seen from the company Dalian Wanda, founded by Wang Jialin, being forced to downsize in 2018 due to excessive borrowing. Mattie Bekink, of the Economic Intelligist Unit, also notes that Evergrande straying from their “core business practices” is part of what has got them into this trouble, also noting that, “The story of Evergrande is the story of the deep [and] structural challenges to China’s economy related to debt.” Now, the world awaits the possible fallout of what could be one of the biggest tests the Chinese economy has faced in recent years. The failings and carelessness of Evergrande have drawn many comparisons to the fallout of Lehman Brothers, which was one of the largest investment banks in the U.S., before collapsing during the Global Financial Crisis in 2008, due to their investment in subprime, or poorly credited mortgage-backed securities. Evergrande has recently halted payments towards suppliers and has seen protestors outside their buildings demanding payments for their wealth management assets. The company has also reached out to debt consolidation companies in recent weeks to examine its finances. In regards to the economic impact of Evergrande defaulting on their debt, this may not turn out to be a “Lehman-like” event, but the ramifications would still be significant. The real estate sector is estimated to make up almost 30% of China’s GDP, and a collapse of one of its largest developers could have a major impact on homeowners that have invested in the aforementioned pre-paid housing, investors, including over 100 financial institutions who have purchased Evergrande debt, as well as the suppliers and real estate used in the construction of Evergrande real estate projects. Chinese Estates, the biggest shareholder in Evergrande, has already announced plans to sell its entire stake in the company. Thus, the results for the Chinese economy could be catastrophic. However, Li Daukui, a former advisor to the People’s Bank of China, does not expect much spillover into the Chinese financial system due to little financial instruments built on the Evergrande debt.
The possibility of a government bailout is being closely monitored. CNN’s Michelle Toh notes that while the government could intervene if the Evergrande crisis began to spill over into other sectors of the economy, this would deviate from the message the government has been trying to send to real estate developers on overzealous spending and excessive borrowing, a phenomenon that has plagued China in recent years. However, with the real estate sector beginning to slow in China, in light of the pandemic, and with shares already falling by 85% this year, a collapse of Evergrande could have massive ramifications, both on other indebted real estate companies, as well as the overarching economy, which may force the hand of the Chinese government to intervene.
Edited by Maggie Reddington