How and why China Evergrande crashed

In January, more than 100 financial sleuths were dispatched to the Guangzhou headquarters of China Evergrande Group, a real estate giant that had defaulted a year earlier under US$300 billion of debt. Its longtime auditor had just resigned, and a nation of homebuyers had directed its ire at Evergrande.

Police on watch for protesters stood guard outside the building, and the new team of auditors was issued permits to get in. After six months of work, the auditors reported that Evergrande had lost US$81 billion over the prior two years, vastly more than expected.

But they still had questions. Some records they had requested from Evergrande were incomplete. Numbers were missing. Important accounting errors or misstatements may have gone undetected. How had things at Evergrande – once one of China’s most successful companies – gone so wrong?

China’s housing boom was the biggest the world has seen, and Evergrande’s rise was powered by rapacious expansion, the system that stoked it and foreign investors who threw money at it. When China’s housing bubble burst, no other company imploded in as spectacular a fashion.

In 2021, the blame for Evergrande’s failure was placed squarely on a political directive from Beijing to cool the market by restricting access to loans by property developers, depriving the debt-saddled company of cash to fund its operations.

But interviews with people close to Evergrande and a reconstruction of publicly available documents offer an alternate explanation: Questionable accounting and poor corporate oversight, leading to problems such as the disappearance of US$2 billion, had already sent the company careening towards catastrophe.

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The scale of Evergrande’s rise was staggering. For three decades, it wielded power in Beijing and in cities and towns thousands of miles away. The success turned its founder and chair, Hui Ka Yan, into one of the world’s wealthiest people and enriched an entire ecosystem – from the local governments that sold it land to the Wall Street banks that charged it fees to raise money.

The breadth of Evergrande’s stumbles was mind-numbing. The company promised hundreds of thousands of homebuyers apartments that it never built. It took in billions of dollars from families and employees, some of which has vanished. It took labour from construction workers, painters and real estate agents without compensation, unpaid bills that have snowballed into US$140 billion.

Today, Evergrande remains in default, unable to pay its debts but not officially defunct. Its stock trades for pennies a share.

On Monday, a legal attempt to force its liquidation was prolonged: A judge adjourned a hearing in a lawsuit seeking to formally dismantle the sprawling company to pay back some of the investors who lost money.

Evergrande officials and its representatives did not respond to several requests for interviews or comment.

China’s housing boom began around the time that Hui started Evergrande in 1996 in the city of Shenzhen, a special economic zone where the Chinese Communist Party was experimenting with capitalism.

Evergrande expanded beyond Shenzhen as China underwent massive urbanisation, and it was central to the world’s largest movement of people from the countryside to cities. Hui ingratiated himself with the families of some of China’s most senior officials. He put Wen Jiahong, the brother of China’s then vice premier, Wen Jiabao, on Evergrande’s board of directors in 2002.

By the time Evergrande started selling stock to the public in Hong Kong in 2009, it had already faced questions about its voracious expansion.

By 2010, the market was showing signs of overheating. Housing prices were rising faster than the average household income. Economists warned that China’s housing market was overpriced, supply was overbuilt and its developers were overleveraged.

Estimates range over how many apartments remain empty. He Keng, a former deputy head of China’s statistics bureau, recently quipped about an estimate that the number of vacant homes was not enough for 3 billion people. “That estimate might be a bit much,” he said in a video published by China News Media. “But 1.4 billion people probably can’t fill them.”

For months in 2021, Evergrande kept global markets on edge as it approached default, testing a belief that some Chinese companies were too big for authorities to let them fail. Foreign investors continued to buy the bonds of real estate developers even after one of the biggest beneficiaries of the housing boom, real estate mogul Wang Jianlin, warned that China’s housing market was “the biggest bubble in history.”

On Dec 9, 2021, three days after Evergrande missed a deadline to pay interest on some bonds, a credit ratings agency declared the company to be in default. That set in motion a struggle among investors, homebuyers, suppliers and banks over how to get what they were owed.

Three months after its default, Evergrande said US$2 billion had been seized by banks. An internal investigation later revealed that top executives had engineered a plan in late 2020 to get around borrowing restrictions by arranging for third parties to take out loans using Evergrande subsidiaries as collateral.

The investigation concluded that the plan breached the company’s disclosure and compliance obligations.Nevertheless, some employees said that “it was not their place to question a matter that was known to and driven by senior executives,” according to the investigation.

Top executives, including the chief financial officer and chief executive officer, resigned. “The behaviour of certain then directors fell below the standards expected by the company,” according to the internal report, which was signed by Hui, the founder.

In January, Evergrande’s longtime auditor, PricewaterhouseCoopers, resigned and said it couldn’t complete its work. Hong Kong’s Accounting and Financial Reporting Council had already announced two reviews of Evergrande’s books. A little-known accounting firm, Prism Hong Kong and Shanghai, was brought in to do the work.

Prism said in July that Evergrande had lost a combined US$81 billion in 2021 and 2022. That compared with what the company said in 2020 was a profit of US$1 billion. There were clues in the new audit that Evergrande had been treating money it had received for apartments as revenue even though at times it had not yet built those apartments.

After the new audit, Evergrande agreed to change how it would recognise revenue in its accounts by requiring documentation that an apartment had first been built.

Evergrande’s wealth management arm, which had pitched short-term and high-interest products to homebuyers and employees when money was tight, told investors in August that it wouldn’t be able to make payments.

Within weeks, police detained staff at the wealth management unit. The Chinese media reported that the company’s former CEO, its chief financial officer and the former chair of Evergrande’s life insurance unit had also been detained.

Behind the scenes, the company’s management team in Hong Kong was making progress toward a restructuring deal with foreign creditors and private lenders. Then, Sept 24, Evergrande said it had to reassess and scrapped the deal. A few days later, it disclosed that Hui had been arrested.

Hui had paid himself and his wife more than US$7 billion in dividends since taking the company public in 2009. He has told people for at least two years that he and his wife were divorced, according to two people with direct interactions with the company who were not allowed to speak to the media. Filings in August indicate that he and his wife were no longer married. Assets that have been transferred to his former wife will be in dispute.

Two years after it defaulted, it is still uncertain how the company will be wound down, how much money will be left and who will get it. NYTimes