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  • Writer's pictureJoel Werner

Evergrande – Is Beijing Preparing to Cut Up Its Grey Rhino?

For months, the world has watched Evergrande’s faltering steps toward collapse, and now, the Chinese property giant is officially in default. As opposed to an unexpected “black swan” event, Evergrande, which is the most indebted real estate developer in the world, has been a lumbering "grey rhino" with the potential to wreak enormous damage on its nation's economy. But, as many experts suspected, Beijing isn't going to allow that to happen.

Central Government Has Been Trying to Control Developer Borrowing

Beijing imposed its so-called "three red lines" borrowing restrictions on real estate developers to stem what the central bank deemed reckless behavior in the industry. Real estate accounts for almost a third of China's GDP. It was immediately apparent that Evergrande was one of the country’s biggest culprits, and it currently holds more than $300 billion in debt.

The group owns developments in almost 300 Chinese cities and has a substantial staff. Its collapse stands to impact ordinary homeowners in addition to financial institutions and wealthy investors both in China and abroad. Accordingly, the situation could have political ramifications for President Xi Jinping. In the central government's official response, blame has been laid squarely on management, with no dilution of the message carried by the three red lines.

Private Investors Aren't Beijing’s Priority

The one advantage of facing a grey rhino, rather than being surprised by a black swan, is the early heads-up it sends to the market. Add to this the fact that state-owned banks mean Beijing effectively controls the real estate market or, at the very least, can predict likely defaulters. While no one is expecting transparency from Beijing, it clearly prepared for Evergrande’s default, and wealthy investors are not its priority.

For example, there is no bailout planned to emulate Washington's handling of the Lehman Brothers at the start of the 2008 financial crisis. In fact, a debt restructuring process reached with Chinese authorities reportedly includes the sale of personal assets belonging to Evergrande's founder and chairman, Hui Ka Yan. He is said to have so far used or pledged $1.1 billion of his personal assets toward the group’s bond interest, salaries, and project operating costs. Recently, Hui's stake in Evergrande dropped from 61.88% to 59.78% due to a forced share sale undertaken to enforce a "security interest." Reuters valued the 277.8 million shares involved at $63 million, based on the stock's closing price at the time.

China's central government will inject $188 billion into the economy to protect against the worsening slump in the real estate market as home prices continue to fall and several other developers default, including Kaisa Group. The government also intends to try to prevent further developers from defaulting by keeping debt costs manageable.

In addition, Beijing wants Evergrande’s incomplete developments finished so that the Chinese families who have paid for them and the contractors and other suppliers who have been contracted for them aren't left high and dry. To this end, the government has taken steps to encourage lenders to fund acquisitions of projects held by distressed developers. This policy may benefit larger, state-owned firms the most.

It Could Take Years to Unwind Evergrande

When it comes to Evergrande itself, experts think Beijing will be more than willing to see the entity itself disappear, likely by being split into more manageable parts. This could take years.

For now, we know that local governments have recently repossessed idle development sites belonging to Evergrande. According to Chinese law, the government can reclaim idle land without compensation if construction hasn’t commenced within two years of the designated start time. Two of the repossessed sites in the city of Chengdu have been idle for more than a decade. A further eight sites have been taken by local government in the city of Haikou.

In the meantime, officials from Guangdong, where Evergrande is based, have been sent in to maintain company operations, fortify internal controls, and oversee risk management. Included in Evergrande’s risk management committee is an executive from a central government-owned bad debt manager.

What Does the Future Hold?

What does all of this mean for the Chinese economy going forward, then? It certainly complicates the government's long-term plans. Beijing has been trying to reduce the country's reliance on its property market and invest in its tech sector. However, the sharp decline in real estate may hamper efforts in this regard by slowing the projected growth of the national economy.

There’s also a danger that international investors will be warier of China going forward if they are forced to “take a haircut” on Evergrande's missing bond interest payments. This will make it more expensive for Chinese developers to get international funding. Beijing may need to loosen its restrictive monetary policies to ensure the industry can maintain access to foreign investors.

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