InFocus: Is Evergrande’s collapse going to be better off for property in the long run?

The collapse of the second-largest developer in China, Evergrande, could be positive for China’s property sector in the medium to long-term as it will deliver a strong message to the private sector and emphasise the critical goal of the Chinese government achieving “common prosperity”. 

Jonathan Wu, executive director at Premium China Funds Management (PCFM), said by allowing Evergrande to collapse more competition and innovation could be created across the Chinese property sector. It would also help “split the pie amongst the remaining players in a more equitable way.”

However, the Chinese property sector would face continued structural headwinds, meaning the days of supernormal profits for developers might be over as the earnings of developers would be less cyclical than before, Wu said.

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According to Wu, one of the significant contributors to the Evergrande situation was last year’s Government introduction of the ‘three red line rules’ which effectively acted as debt covenants for property developers.

These three lines were:

  • Liability to asset ratio (excluding advance receipts) of less than 70%;
  • Net gearing ratio of less than 100%; and
  • Cash to short-term debt ratio of more than one.

“These three red lines is effectively the method by which the government has nationalised debt covenants on companies to effectively stop them from borrowing so much to contain the fear of never-ending growth in property. Evergrande has breached all of three of those red lines, meaning it had become very difficult for them to continue borrowing,” Wu said.

He said the ultimate goal of the Chinese government was not to save the company but to ensure properties were delivered to those who purchased them. Selling off the

Evergrande sites to other developers would also show the public the government was on its way to achieving “common prosperity”.

The Chinese banking system was largely government owned/backed which, in cases like Evergrande, would help ensure an orderly potential restructure of the debt. 

“So the longer term prognosis on the property market on the basis that Evergrande collapses is good because it serves a very strong message to all the other developers that are currently in the breach of those three red lines and pushes those developers to even more aggressively deleverage their own books. It would also send a strong signal for companies to ‘watch their own backs’ and successful deleveraging would help create a more sustainable property market.”


Federated Hermes believed the impending bankruptcy of Evergrande, which has ¥2.3 trillion ($495.2 billion) of assets on its books – an equivalent of 2% of China’s gross domestic product (GDP), would definitely result in some casualties. 

However, the firm said in a note, it believed a collapse would remain contained if an “administrative support” programme was implemented by the government.

“We expect Evergrande to ultimately file for bankruptcy in the coming weeks. However, the contagion will be limited both globally and domestically by virtue of the Chinese authorities’ absolute power and willingness to pull whatever levers it needs to avert instability. Numerous companies across the mainland and beyond will be used to absorb the shock and spread-out the impact,” said credit analyst Robin Usson. 

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