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China Won’t Save Evergrande for Many Good Reasons
Many of the country’s debt-laden developers believe they are immortal because Beijing hasn’t proven that it’s serious about reforms.
By
Shuli Ren
October 15, 2021, 9:21 AM EDT
Unfinished business: China Evergrande Group's Cultural Tourism City in Jiangsu province.
Photographer: Qilai Shen/Bloomberg
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With Chinese high-yield issues experiencing their worst selloff in a decade, murmurs are growing that China is poised to blink and relent on its property tightening measures. That hope was shattered on Friday.
At a news briefing, the People’s Bank of China broke its silence on China Evergrande Group and said financial risks posed by distressed property developer, which is on the brink of a $300 billion debt restructuring, is “controllable.” That is a code word for “no bailouts.” The central bank tossed the blame to Evergrande. “In recent years, the company failed to manage its business well and to operate prudently amid changing market conditions,” an official said. “Instead it blindly expanded and diversified.”
And so, China’s real estate developers are poised to enter their harshest winter ever. With over 400 tightening measures this year alone, property sales at major developers slumped by as much as 30% in September. Financing has also become impossible. Is China being too harsh on an industry that makes up 15% of its gross domestic product?
The PBOC can be forgiven for being cold-blooded. This is not the first time China has tried to tame home prices. In the last decade, there have been at least three tightening cycles. However, the country’s clever, unruly and resourceful developers always found a way to profit. Even with its steely knives, Beijing couldn’t kill the beast.
Where the Wild Beasts Are
China has launched three tightening cycles on its real estate market. But the previous two were too short, and the latest one had no bite till recently.
Source: Bloomberg, Autonomous
Note: Data smoothed out with three-month moving average
Some of the developers’ financing deals were worthy of death-defying circus acrobats. One tactic was to scale-up at all costs — because size matters. Banks won’t lend unless you are perceived as too-big-to-fail. The moment you have access to much cheaper bank loans, the average cost of borrowing will come down substantially. It’s an extreme and tough act. But some developers managed to do it.
Mainland developers have abused practices that work elsewhere. Pre-sales, for example. In Hong Kong, apartments are sold even before they are built but there are no problems with delivery because the city’s big property tyc00ns are cash rich. Not so on the mainland. Because of working capital issues, Evergrande still has to deliver 1.6 million homes to consumers who have already paid.
There are other daredevil antics. We recently discovered that Evergrande was borrowing from everyone, including its own employees and suppliers. And this practice is by no means an Evergrande invention. Asking staff to co-invest was commonplace among the more aggressive developers.
Fujian Fusheng Group Co., a luxury builder, did that via trust products its own employees had bought. The company promised a 30% return in less than a year. It deployed a so-called “3691” model, vowing to break ground on new developments in three months, start pre-sales in six months, finish construction within nine months, and return the money with interest in a year. It’s high churn, high leverage. And, surprise, Fujian Fusheng has gone into default.
But what gives any company the confidence to swallow 30% in financing costs?
The problem is that Beijing never really convinced developers that it was serious about reform. It’s almost a policy embarrassment. The government never quite loosened its home purchase policies despite President Xi Jinping talking up his mantra of “housing is to be lived in, not speculated on” way back in December 2016. Even in the midst of the trade war, the Politburo pledged not to use the property market as stimulus. In the first-half this year, the country’s 50-plus listed developers accrued $2.5 trillion in liabilities, almost double that of 2017, data compiled by Bloomberg Opinion shows. In other words, they continued to expand, going against Xi’s will.
Even now, as China’s overall home price growth slows because of Beijing’s latest initiatives, there are still pockets of opportunities for aggressive developers. For instance, the city of Dongguan — a manufacturing hub with 7.4 million people that borders the tech hub of Shenzhen — saw housing prices surge nearly 30% last year and another 8.5% this year. If developers worked fast enough bidding, building and selling, they’d have made a handsome return.
So, there is logic to the government killing a few beasts — that is, letting some developers go bust — just so they learn a different way of doing business. Beijing, don’t blink this time.
Asking employees to invest? This is so wild. IMO, China has let this linger to prevent global financial collapse from impacting holiday-season exports. Now that goods have been mostly sent out, wouldn't be surprised if they let Evergrande collapse.
