Evergrande, 2021Medium

A property developer funded by presales, supplier credit and offshore bonds. When new sales slowed, three sources of funding stopped at once — and the bondholders were furthest from the assets.

4 min read · 708 words

What happened

• The model — a large property developer funding construction from three sources at once: buyers paying for apartments before completion, suppliers and contractors extending credit, and borrowing, including bonds issued offshore in US dollars.
• 2020 into 2021 — policy measures constrained leverage in the sector, new borrowing became harder, and sales slowed. Presale proceeds fund construction, and construction is what makes the next presale possible, so a slowdown removed the input to its own engine.
• Late 2021 — missed coupon payments on offshore bonds and a formal declaration of default by rating agencies, with construction on unfinished projects stalling in many places.
• Afterwards — a prolonged restructuring across two legal systems, a Hong Kong court winding-up order in 2024, and a sector-wide reassessment of developer funding. Whether an offshore liquidator could reach onshore assets remained the central open question throughout.

The mechanism

• Presale funding makes a developer's growth its own collateral. Money from buyers of unbuilt units pays for construction; completed construction supports the next round of sales. It is efficient while sales grow and it has no steady state — a pause is not a slower version of the same thing, it is the removal of the funding.
• Three funding sources with one common cause. Buyers, suppliers and bond investors were formally independent and all three responded to the same signal. Diversification of funding sources is only diversification if the sources fail for different reasons.
• Structural subordination decides who gets paid. An offshore bond is usually issued by a holding company whose only asset is shares in the operating subsidiaries. Every creditor of those subsidiaries — banks, suppliers, and the buyers with claims on their apartments — is paid from the assets before anything reaches the holding company. The offshore bondholder is not lower in the same queue; they are in a different queue that starts once the first one is finished. What you get if the company goes bust is the general version.
• Unfinished apartments are a political claim as well as a legal one. Buyers who have paid for homes that do not exist are a constituency, and completing those projects can rank ahead of any creditor's recovery in practice whatever the documents say. A restructuring where one class of claimant is also a social obligation does not behave like a textbook waterfall.
• A cross-border restructuring is two proceedings that must recognise each other. An order in one jurisdiction reaches assets in another only to the extent that jurisdiction's courts permit, which is why enforcement, not the order, was the live question — see restructuring transactions.

What it teaches

• Ask which entity issued the bond, and what that entity owns. This single question separates a claim on assets from a claim on a share in a company that owns assets, and it is answerable from the prospectus before anything goes wrong.
• Count funding sources by their cause, not by their name. Three lenders responding to one condition are one lender.
• A model that requires growth has no stable state. Distinguish businesses that slow down from businesses that stop, because they behave differently at the same fall in demand.
• Recovery is a process in a jurisdiction, not a number in a model. Two identical claims recover differently depending on where the assets are and which court is asked. Spread measures price an assumed recovery; the assumption is the interesting part.
• Read the sector's rules as a cash flow. The leverage measures that constrained the sector were public and dated, and their effect on a presale-funded developer was arithmetic rather than a surprise.

The mechanisms behind this

• What you get if the company goes bust — the queue, and where an offshore bondholder stands in it.
• High yield bonds — the instrument, and what its documents do and do not promise.
• Restructuring — what a cross-border process actually involves.
• Spread measures — the recovery assumption inside a quoted spread.