China Evergrande’s crash was precipitated by questionable accounting

In January, more than a hundred financial sleuths were sent to the Guangzhou headquarters of China Evergrande Group, a real estate giant that had defaulted a year earlier on debts of less than $300 billion. The old accountant had just resigned and a nation of homebuyers had turned their ire on Evergrande.

Police stood guard for protesters outside the building and the new team of auditors were allowed to enter. After six months of work, the auditors reported that Evergrande had lost $81 billion over the past two years, much more than expected.

But they still had questions. Some of the data they requested from Evergrande was incomplete. Figures were missing. Significant accounting errors or discrepancies may have gone unnoticed. How had things gone so wrong at Evergrande – once one of China’s most successful companies?

China’s housing boom was the biggest the world has ever seen, and Evergrande’s rise was driven by predatory expansion, the system that stoked the housing market and foreign investors throwing money at it. When China’s housing bubble burst, no other company imploded in such a spectacular way.

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 for property developers, depriving the debt-saddled company of cash to fund its operations .

But interviews with people around Evergrande and a reconstruction of publicly available documents offer an alternative explanation: Questionable accounting and poor corporate oversight, leading to problems like the disappearance of $2 billion, had already pushed the company toward disaster.

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. Its success made its founder and chairman, Hui Ka Yan, one of the richest people in the world and enriched an entire ecosystem – from the local governments that sold land to the Wall Street banks that charged fees to raise money.

The magnitude of Evergrande’s stumbles was mind-numbing. The company promised hundreds of thousands of homebuyers apartments that it never built. It cost families and workers billions of dollars, some of which is gone. Labor was required from construction workers, painters and real estate agents without compensation, unpaid bills amounting to $140 billion.

Today, Evergrande remains in default, unable to pay its debts, but not officially dissolved. The stock trades for cents per share. On Monday, a legal effort to force the liquidation was extended: A judge suspended a hearing in a lawsuit that sought to formally dismantle the sprawling company to repay some of the investors who had lost money.

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

A housing boom that was too expensive, too much built and too much debt.

China’s housing boom began around the time Mr. Hui founded 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 urbanization, and it played a central role in the world’s largest movement of people from rural areas to cities. Mr. Hui had ingratiated himself with the families of some of China’s top officials. He placed Wen Jiahong, the brother of then Chinese Vice Premier Wen Jiabao, on Evergrande’s board of directors in 2002.

By the time Evergrande started selling shares to the Hong Kong public in 2009, it was already facing questions about its voracious expansion. Foreign investors, including many U.S. private equity funds, hedge funds and Wall Street banks, had poured money into real estate companies a few years earlier, and debts were piling up. Mr Hui had hoped to raise $1.5 billion, but the company ended up making $722 million from the listing of its shares.

A global financial crisis was reverberating around the world, a crisis that began with a decline in housing prices in the United States. But in China, after a short and sharp downturn, the government pumped $500 billion into road and rail construction, boosting growth and helping China emerge from the crisis before other countries. By listing its shares in Hong Kong, Evergrande had access to money outside China to buy land in China. Dozens of other developers did the same. Three of them – Kaisa Group, Yuzhou Properties and Fantasia Holdings – raised money in the same few weeks as Evergrande. They have all defaulted since.

In 2010 the market showed signs of overheating. House prices rose faster than the average household income. Economists soon warned that China’s housing market was too expensive, that supply was too high and that developers had too much debt.

Regardless, Chinese homebuyers continued to flock to construction projects. As cities filled with new apartment complexes, developers looked further afield to satellite towns and more rural areas.

Potential buyers were guided past showrooms and model apartments and then given a piece of paper to sign. For a third of the price of an apartment, and sometimes even more, they bought a promise, an apartment not yet built. For households with few places to store their wealth, it was hard to imagine how a bet on real estate could go wrong.

But things went wrong. Over the past decade, authorities have tried to rein in lending, but real estate companies have found ways around each restriction, sometimes by cutting back on apartments, sometimes by removing debt from their balance sheets. Ultimately, a policy in 2020 that made it harder to borrow pushed developers over the cliff.

Estimates vary as to how many apartments are vacant. He Keng, former deputy head of China’s Statistics Bureau, joked recently about an estimate that the number of vacant homes was not enough for three billion people. “That estimate may be a bit much,” he said in a video published by China News Media. “But they probably can’t fill 1.4 billion people.”

‘The largest bubble in history.’

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

On December 9, three days after Evergrande missed a deadline to pay interest on some bonds, a credit rating agency declared the company in default. That set off a battle among investors, homebuyers, suppliers and banks over how to get what they were owed.

The collapse of Evergrande was just one domino on a falling line. Since then, 46 other developers have defaulted, leaving a landscape of boarded-up construction sites, angry homebuyers and unpaid builders. Concerned about social unrest, authorities have quietly pushed for the companies to continue building apartments. Evergrande built 300,000 apartments by 2022, while the company spoke to its creditors about repaying them.

But years of poor corporate governance and behavior at Evergrande spread to the public as financing became more difficult to obtain.

Three months after the bankruptcy, Evergrande said its banks had seized $2 billion. An internal investigation later revealed that top executives devised a plan in late 2020 to circumvent lending restrictions by arranging for third parties to take out loans using Evergrande subsidiaries as collateral.
The investigation concluded that the plan violated the company’s disclosure and compliance obligations.

Still, some employees said that “it was not their job to challenge a matter known and directed by senior executives,” according to the survey.

Top executives, including the Chief Financial Officer and the Chief Executive Officer, resigned. “The conduct of certain then-directors did not meet the standards expected by the company,” said the internal report, which was signed by Mr Hui, the founder.

In January this year, Evergrande’s longtime accountant, PricewaterhouseCoopers, resigned, saying it could not complete its work. The Accounting and Financial Reporting Council of Hong Kong 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 $81 billion in 2021 and 2022 combined. Compared to what the company said in 2020, that was a profit of $1 billion. There was evidence in the new audit that Evergrande had treated money it received for apartments as income, even though sometimes it had not yet built those apartments.

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

Evergrande’s wealth management division, which had promoted short-term and high-interest products to homebuyers and employees when money was tight, told investors in August that it would be unable to make payments.

Within weeks, police arrested staff from the asset management department. Chinese media reported that the company’s former CEO, Chief Financial Officer and former chairman of Evergrande’s life insurance division had also been arrested.

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, on September 24, Evergrande said it had to reassess the deal and scrapped it. A few days later it was announced that Mr Hui had been arrested.

Comments about how Mr Hui had become “an enemy of the Chinese people” appeared on Chinese social media. People focused their anger on foreign investors and an attempt by the company to file for bankruptcy protection. Famous entrepreneurs piled on foreigners who would get a share of the remaining business that belonged to home buyers.

Mr. Hui has paid himself and his wife more than $7 billion in dividends since taking the company public in 2009, according to company filings. He 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 authorized to speak to the media. Filings in August show that he and his wife were no longer married. Assets transferred to his ex-wife will be in question.

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