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Will Chinese Property Giant Evergrande Ever Pay the Piper?

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All across China, new office and apartment towers sit completely vacant, built, and then forgotten. For years foreigners have been fascinated by the growing ghost cities, perplexed at the pace of development and lack of apparent consequences to rampant overbuilding. A real estate bubble has been brewing in China for a decade. A debt crisis embroiling China’s second-largest property developer Evergrande may be the first sign it’s about to pop, but it’s still unclear if the company will ever be forced to pay the piper for years of heedless construction.  

Financial markets have been holding their breath as the weight of $305 billion in debt threatens to crush Evergrande. Short on cash and long on obligations, investors around the world are watching with bated breath, worried the firm’s collapse could cascade into a crisis that threatens China’s and the world’s financial markets. Evergrande missed a deadline for an $83.5 million bond interest payment, going radio silent. The company will have 30 days to make the payment before default.

The size of Evergrande and its growing debt problem cannot be overstated. The company employs 200,000 workers, developing 1,300 projects in 170 cities. Evengrande controls more than 565 million square feet of real estate across the mainland, making it the second-largest property company in China. The value of the company’s total assets is estimated at roughly $306 billion, the company is carrying $305 billion in debt, risking a liquidity crisis. Evergrande is the most indebted property developer in the world. 

“There’s no precedent to this at the size of Evergrande … we have to see in the next 10 days or so, before China goes into holiday, how this is going to play out,” Howe Chung Wan, the head of Asia fixed income at Principal Global Investors in Singapore, told The Guardian. 

Uncertainty surrounding Evegrande’s future is bringing pause to financial markets, but despite minor drops, most investors seem bullish. Unlike other major financial institutions whose collapse caused a global financial crisis, Evergrande does not have major ties to global finance. Major lenders outside of China have not lent significant amounts. Total exposure from Evergrande for what lenders are carrying the firm’s bonds like UBS, HSBC, and Blackrock have been declining, according to Morningstar. Total exposure to the indebted developer has been declining steadily through the year for all lenders. Zheshang Bank, one of Evergrande’s biggest lenders, is owed nearly $600 million but has called the overall risk “controllable.” The company may be set to lose hundreds of millions, but the crisis is likely to be contained. 

Still, the Chinese government is preparing for the fallout. The country’s financial regulator, the Financial Stability and Development Committee, told local governments to prepare for unrest by monitoring social and economic conditions for concerns. Provincial governments were ordered to assemble teams of accounts and lawyers to vet finances around Evergrande’s projects in their areas. 

China’s social market economy, largely controlled by the state, has many thinking Evergrande will be bailed out, but experts say that’s not a given. Officials from Beijing may step in to ensure individuals and businesses get the assets they already paid for, but a full bailout looks unlikely. Beijing may take the opportunity to use Evergrande as a lesson that the government won’t always be a backstop. Chinese regulators have been working to break the country’s reliance on debt, implementing a ‘three red lines’ policy on property companies, setting limits on debt-asset, debt-to-equity, and cash-to-short-term-debt ratios. A bailout for a business that exceeded those redlines threatens moral hazard. On the other hand, allowing Evergrande to tank could lead to civil unrest during the approaching Golden Week holiday in China, eight days of paid leave meant to spur domestic tourism and spending across the nation. 

Evergrande is at the epicenter of China’s real estate crisis. The property sector accounts for roughly 25 percent of China’s GDP. The problem is that the Chinese property sector is ‘notorious for its addiction to debt’ according to Michael Pettis, professor of finance at Guanghua School of Management at Peking University in Beijing. Pettis points out that it isn’t just borrowing from banks and bond markets, Chinese property developers regularly pre-sale apartments, sometimes years in advance, paying contractors and suppliers with receivables and commercial paper instead of cash. 

So much debt has made China’s property sector one of the country’s main economic drivers, but the Chinese government is finally realizing the scale of the problem. Experts estimate up to 25 percent of the country’s housing stock could be vacant, owned by investors with no interest in renting, selling, or living in the space. The assets don’t move and debt ratios only go up because there’s an implicit understanding that China’s largest companies will never be allowed to default. Letting Evergrande deal with the consequences would be the first serious sign that China intends to reform its entire credit market by forcing lenders to be more discerning about investments. 

President Xi Jinping penned an essay in the Party’s leading journal Qiushi calling much of the growth fueled debt Chinese property developers are known for ‘fictional growth.’ Jinping called to shift the country’s focus from pursuing inflated GDP growth to achieving “high-quality, efficient, and sustainable development.”

The inflated growth Jinping speaks of can be seen in the ghost cities littered across China, pumping up GDP numbers with never-ending construction no one is using. For years experts have wondered how long China can keep it up. We may soon have an answer to that question. Regardless of the future of Evergrande and whether or not they are bailed out, China’s property sector is due for a reckoning.

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