The first of a three-part series on the China Evergrande Group looks at how the world’s most indebted developer grew to its current size and how it avoided scrutiny when China’s authorities cracked down on debt in 2017. On an overcast Monday in early 2017, Hui Ka-yan chaired a staff meeting in Guangzhou, where he set an audacious goal for China Evergrande Group, one that would land the developer four years later in the eye of a storm that is ripping across the financial world.
Sitting on a raised podium with the most senior executives to his sides and behind him, Hui outlined Evergrandes’s growth and diversification plans in a speech that rambled on for three hours. Then headquartered in the Guangdong provincial capital, and bolstered by a 60 per cent revenue surge a year earlier, Evergrande wanted to hit 1 trillion yuan (US$154.8 billion) in sales by 2020, almost five times its 2016 turnover, according to a Xinhua News Agency report.
Outside Evergrande’s windows that February morning, a regulatory storm was gathering, as the Chinese overseers of banking, insurance and securities led by the People’s Bank of China came crashing down on the country’s most profligate asset buyers. Regulators were concerned that bank loans were mounting too quickly, raising the spectre of capital flight as onshore loans were used to buy offshore trophies without adding anything to China’s economy. Worse still, some companies were selling wealth management insurance products to the public, using them as financial war chests to fund their shopping sprees.
The crackdown intensified two months after Hui’s marathon speech, leading to the break-up and downsizing of four of China’s biggest private conglomerates: Anbang Group, CEFC Group, Dalian Wanda Group and the HNA Group. HNA’s founder Chen Feng and chief executive Adam Tan Xiangdong were detained by police for suspected “criminal offences,” the company said on Friday, without elaborating.
Hui Ka-yan (centre) chairing a staff meeting on February 13, 2017 in Guangzhou, where he laid out a three-year growth and diversification plan for China Evergrande Group to achieve 1 trillion yuan in sales by 2020. Photo: Xinhua
But Evergrande was mostly spared, except for a rap on the knuckles of its Evergrande Life unit for a failed attempt to take over rival developer China Vanke Group. It continues to sell wealth management products to this day after stepping into line with regulators’ instructions.
“2017 was not the time to take action on Hui, because he was not on the radar from the regulators’ point of view, thus he was able to continue to move forward” with his plans, said Tommy Wu, senior economist with Oxford Economics in Hong Kong. “But now it is the time” to act, seeing how big his business had ballooned, he said.
Evergrande, based in southern China’s technology metropolis of Shenzhen since August 2017, has the dubious honour of being the world’s most indebted developer, with US$300 billion in total liabilities, compared with 2.38 trillion yuan in assets. It is holding the world’s banks and capital markets on tenterhooks as it grapples with US$120 million in interest payments due this week, 30 per cent of which was postponed in “off-exchange negotiations” with holders of a smaller, onshore bond.
Hui Ka-yan (standing, third right) and his wife Ding Yumei (standing, third left) with townsfolks and kin at his old home in Henan, during a visit on December 15 – 16, 2018. Photo: Securities Times.
Hui, also known as Xu Jiayin on the mainland, was born in a village in Gaoxian, a town of fewer than 50,000 residents in central China’s Henan province. Raised by his paternal grandmother, Hui studied metallurgy at what was then the Wuhan Institute of Iron and Steel, before finding work in the local steel mill.
In 1987, a groundbreaking policy was enacted in a fishing village near Hong Kong, under the capitalist market reforms ordered by the paramount leader Deng Xiaoping. Local authorities in Shenzhen sold the first land-use rights to a state-owned company, setting the precedent for communal land to be used for private housing. A year after Shenzhen’s pioneering move, a national law was enacted to officially define the concept of “economically affordable housing” and “commodity housing,” or privately owned homes in today’s parlance.
Attracted by the reforms, Hui quit his steel job in Wuhan in 1992 and headed for southern China. He first landed a job in trading, where he rode the wave of China’s growing commerce with the world, and the rising tide of entrepreneurship that was replacing almost every aspect of communal ownership with private holdings.
A snapshot of China Evergrande Group's assets and liabilities. Source: Goldman Sachs
Four years later, Hui founded Evergrande in Guangzhou, where he went about building high-rise apartments, selling them to buyers in a housing market that was barely 10 years old.
In the late 1990s before China joined the World Trade Organization (WTO), the property industry was dominated by large state-owned developers with the capital and access to the best locations. Apartments were large, and priced beyond the affordability of all but the wealthiest buyers.
Hui focused instead on building affordable homes for the mass market, delving deep into his own memory as a village kid dreaming of city life. He borrowed to build at low costs, selling his apartments off-plan, and using the high turnover to generate cash flow to fund his growth.
“Developers like Evergrande raked in billions relying on the presale scheme and high leverage in the early days of China’s economic reforms, and there’s a historical reason for allowing that,” said Gan Li, a professor at Southwestern University of Finance and Economics. “Now times have changed. What the government needs is not highly leveraged companies or billionaires, but for the sector to return to rational growth.”
Hui Ka-yan being chased by the media during the annual meeting of the Chinese legislature in Beijing in 2012. Photo: Weibo
Still, Hui’s strategy worked. Twelve years after its establishment, Evergrande went public in a HK$6.5 billion initial public offering (IPO) in Hong Kong.
By the time Evergrande turned 21 in 2017, it was already the world’s biggest property developer by sales, surpassing its long-time, crosstown rival Vanke. Hui topped the 2017 Forbes China Rich List, with his wealth estimated at US$42.2 billion.
Along with Hui’s wealth and Evergrande’s size came the baubles and trophies. Evergrande bought a football team in 2010, spending lavishly to sign international players. Guangzhou Evergrande FC, China’s richest football club and half-owned by this newspaper’s owner Alibaba Group Holding, won an unprecedented seven consecutive tournaments in the Chinese Super League that year.
The company branched out into the capital-intensive business of making electric cars, raising US$3.35 billion in January for its China Evergrande New Energy Vehicle Group unit. Seven months later, with US$75 billion of market value wiped out, the unit is yet to produce a single car.
Fans of the Guangzhou Evergrande FC during their team’s AFC Champions League group match with Eastern SC (HKG) in Guangzhou on 22 February 2017. Photo: K.Y. Cheng
Real estate is one of China’s most tightly regulated industries, overseen by a plethora of regulators from the central bank to the economic planner, over concerns of its impact on the economy and the banking system. Every few years, authorities would step in with a potent mix of monetary policies and administrative rules to deflate any signs of a housing bubble, and to deter speculation.
The latest campaign, summed up by the Chinese president’s 2017 edict that “homes are for living in, not for speculation,” culminated in a central bank crackdown in August 2020 on unbridled borrowing. Dubbed the “three red lines,” the plan caps developers’ loans until 2023.
“That forced Evergrande to boost its capital and cash through price cutting,” said Bondcritic’s managing director Warut Promboon, who has been monitoring the developer’s debts for 10 years in Hong Kong. “The three red lines really tipped the balance.”
Hui Ka-yan at Tiananmen Square in Beijing on July 1, 2021. Photo: Sohu.com
This was not Hui’s first brush with a liquidity crunch. When home prices slumped across China’s major cities in 2015, Evergrande received a 100 billion yuan lifeline from Bank of China and the Agricultural Bank of China.
Chinese banks were ordered in June to stress test their balance sheets for exposure to Evergrande after it defaulted on commercial bills. Hui, who turns 63 next month, was spotted and photographed on July 1 by the media as he appeared in Tiananmen Square in the Chinese capital as a guest to watch the celebrations of the Communist Party’s centenary.
“The situation now is far different from what we expected in June,” said Zhou Chuanyi, a credit analyst at Lucror Analytics in Singapore.
Each time he had to sell an asset, Hong Kong magnate Joseph Lau Luen-hung, the founder of Chinese Estates Holdings, was there as the buyer, according to a timeline of the deals between the two going back to 2009.
Chinese Estates Holdings’ former chairman Joseph Lau Luen-hung (right) and his wife Chan Hoi-wan (left) during the real estate tycoon Walter Kwok Ping-sheung's funeral service at the St. John’s Cathedral in Central on 1 November 2018. Photo: Felix Wong
Not any more. The turning point took place in late July, when Evergrande unexpectedly reneged on a special dividend payout to shareholders, two weeks after pledging it, beginning a downwards spiral that sent Evergrande’s shares and bonds crashing.
Chinese Estates, one of Hui’s staunchest allies since 2009, dumped 108.9 million Evergrande shares between August 30 and September 21, even at the expense of losing HK$1.38 billion from selling the stake. And the Hong Kong developer, which still occupies the top floor of the 26-storey waterfront office tower sold in 2015 to Evergrande – to be paid in six annual instalments until this year – said it would dispose of its remaining 5.66 per cent Evergrande stake “depending on prevailing market conditions.”
The situation continued to deteriorate on September 11, when protesters crammed Evergrande’s Shenzhen head office demanding refunds of their wealth management products.
“So when it rains, it pours,” said Promboon.
The piling debt woes are drawing comparisons between Evergrande and the quartet of Chinese conglomerates – Anbang, CEFC, HNA and Wanda – that were cut down into bite-sized businesses after their debt binge. Last week, HNA was broken into four separate businesses after entering bankruptcy.
Like HNA, a bankruptcy restructuring under state ward may happen as Evergrande struggles to prevent US$15.7 billion of offshore bonds and 56 billion yuan of onshore debt from defaulting, leading global investors like George Soros to warn of systemic risks to China’s financial system posed by the nation’s 2.4 trillion yuan in external debt.
“I do see Evergrande following HNA’s path,” said Promboon. “It will become a smaller Evergrande following the sale of noncore assets to repay debts. However, Evergrande is quintessential a property company so the break-up will not be so dramatic.”
Some commentaries are already pointing to Evergrande as China’s “Lehman moment,” referring to the 2008 collapse of the US investment bank.
A snapshot of the gearing ratios among China's big developers. Source: Jefferies.
“Not even close,” said a Barclays report on September 20. The effects could spill over to China’s property sector, with economic implications. But the US$300 billion in liabilities is not large enough to tip the scale of China’s banking system which has as much as US$40 trillion to US$45 trillion in assets, and total loans of over US$30 trillion, Barclays said.
Evergrande’s difficulties are playing out just as China Huarong Asset Management is in the middle of a recapitalisation exercise.
That means two of China’s largest offshore bond issuers are testing the capacity and appetite of the government to backstop potentially substantial failures, S&P Global said.
Although Evergrande’s potential defaults represent a fraction of China’s financial system, the high-profile cases have rattled investors since the common perception has been that the Chinese government will not let state-supported firms fail, analysts said.
Many investors and international banks believe Beijing could soon put forward a plan or make some meaningful progress to reduce the impact. While many questions remain unanswered, one thing is for sure: bondholders are likely to be the last to be refunded, in a long queue behind homebuyers, contractors, banks, and wealth management product investors, analysts said.
“Pricking the bubble created by developers like Evergrande is a very good way to give a lesson to the entire sector and show the determination of the government to stabilise the housing market,” said Gan.Internet Explorer Channel Network