Why did China even allow Evergrande to last this long?

Many comparisons have been made lately between the collapse of Lehman Brothers Holdings Inc. and the apocalypse at China Evergrande Group, the world’s most indebted real estate developer. But they are nowhere close. Lehman was a top-tier investment bank that went from good to bad during the 2007 subprime mortgage crisis. On the other hand, Evergrande — a well-known presence in Hong Kong’s capital markets for years — has always been bad.

For almost a decade, critics have been calling Evergrande out, questioning the asset quality of its unsold properties and asking if its auditors were asleep. All those warnings fell on deaf ears — and the developer-turned-conglomerate went on living out its nine lives. On Thursday, however, Beijing finally told local governments to prepare for Evergrande’s potential demise, the Wall Street Journal reported. The unanswered question is why the People’s Republic of China and its often merciless regulators allowed it to go on for so long.

Evergrande’s liquidity crisis came about because all of its working capital is tied to its inventory, which is largely composed of $202 billion in unfinished housing projects. When unpaid suppliers and employees — who had also been asked to purchase wealth management products sold by the company — came knocking on its door, all Evergrande could offer in terms of repayment was unsold apartments, store fronts and empty parking lots. Some properties were offered to creditors at a discount of as much as 52%, giving a sense of their true market value. It should not be a surprise: There were warnings of “dead assets” from GMT Research five years ago.

Perhaps investors chose to look on the bright side because the authorities were on Evergrande’s side. In 2016, Hong Kong’s Securities and Futures Commission — which regulates the city’s financial markets — declared that U.S.-based short-seller Citron Research and its founder Andrew Left were culpable of market misconduct because of their negative assessment of Evergrande. “Left used sensationalist language in his report that Evergrande was insolvent and engaged in accounting fraud,” the commission said. Left responded, saying, “This court’s opinion simply stifles negative commentary.” Evergrande is among the most often shorted stocks on the Hong Kong bourse.

Short sellers now may be feeling vindicated. But if anything, the Hong Kong SFC’s 2016 decision could have simply emboldened Evergrande. Founder Hui Ka Yan has relied on powerful tycoon friends in the financial center and, over the years, they have short squeezed naysayers, helped Hui raise billions of dollars in equity financing, and even solidified his control of a regional Chinese bank, which happens to be listed in Hong Kong. Owning a bank can be very useful for a developer whose balance sheet is stretched to the limit.

All the SFC did was issue “high shareholding concentration” statements, twice, in 2015 and 2020, both for what was then Evergrande’s health division, warning that the stock was closely held by a small group of investors. That unit was renamed China Evergrande New Energy Vehicle Group Ltd. and, as of early August 2020, 94.8% of it was owned by Hui and 18 shareholders — including his tycoon friends. Its shares have been more volatile than Bitcoin.

Evergrande became Asia’s largest high-yield dollar bond issuer. Its sheer size and liquidity meant that the world’s biggest asset managers, from Pacific Investment Management Co. — or Pimco — to BlackRock Inc., had holdings. It had liabilities with 128 banks last year. What kind of exposure might global banks — such as HSBC Holdings Plc and JPMorgan Chase & Co. — have?

If Hong Kong’s laissezfaire traditions excuse its lax regulation of Evergrande, the inaction across the border in mainland China is just as baffling. Beijing had vowed to cut down corporate leverage in late 2017: It was during this period that Evergrande’s debt pile ballooned.

Were Beijing’s iron-fisted regulators distracted? In 2017, China was busy cracking its whip at conglomerates like Anbang Insurance Group, HNA Group Co. and another property developer Dalian Wanda Group Co., for debtfueled global shopping sprees — which were seen as a way to get money out of China. Evergrande was being the good stay-at-home citizen, aggressively expanding domestically, building projects in lower-tier cities instead. (The enormous metropolitan centers of Beijing, Shanghai, Shenzhen and Guangzhou are first tier cities; tier three cities range in population from 150,000 to 3 million; tier two lies in between.)

But those virtues were piling up bad debt. Between 2016 and 2020, Evergrande’s liabilities almost doubled to about $300 billion. Its working capital became strained. Unpaid bills owed to suppliers ballooned to about 30% of total liabilities, versus 20% five years earlier. Because of its large exposure to lower-tier cities — over half of its land bank is in Tier-3 — its inventory of unfinished projects were difficult to move, averaging 3.5 years by 2020. Those are very dead “dead assets,” to use GMT’s terminology.

Still, Hui and his conglomerate persevered. He ticked all the right boxes. He was “woke” — in Communist party terms — even before Xi Jinping decided to wake the country to its old socialist values. A party member for more than 35 years, the 62-year-old Hui was already speaking of “common prosperity” in 2018. In 2020, with 3 billion yuan ($465 million) in donations, Hui ranked as China’s most charitable person, the fourth year in a row. He was particularly proactive with the Covid19 pandemic, contributing cash to Wuhan one day after its lockdown and donating millions of dollars to medical research. Hui was given a much coveted spot at the Tiananmen Square gate tower at the 70th anniversary of the People’s Republic on Oct. 1, 2019, and again, at the Party’s 100th birthday party this July. In that way, he was more enlightened than other Chinese tycoons, such as Jack Ma.

It worked. Authorities from small, lower-tiered cities would be intoxicated by Hui and his very visible political correctness and connections — welcoming his development projects and proposals with open arms. “Everything Evergrande and I have belong to the party, the country and the people,” he said in that much-cited 2018 speech. If it sounded grand and charitable then, it feels ominous now.