Analysis: what’s hiding underneath? Hidden debt fears fuel China’s real estate problems


A traffic light is seen near the headquarters of the China Evergrande group in Shenzhen, Guangdong province, China on September 26, 2021. REUTERS / Aly Song / File Photo

  • Investors don’t trust Chinese property developers’ accounts
  • Private bonds emerge as a new concern
  • Real estate debt problem bigger than it looks, analysts say
  • China’s central bank says economy faces default risks

SHANGHAI / LONDON, Oct 21 (Reuters) – The numbers don’t lie, just look at the good ones.

That’s the problem for investors looking for China’s next real estate hotspot as industry giant China Evergrande Group (3333.HK) heads for what is expected to be the country’s biggest corporate flaw. country. The numbers on the books sometimes don’t tell the whole story.

Since Beijing began reducing corporate debt in 2017, many real estate developers have turned to off-balance sheet vehicles to borrow money and bypass regulatory oversight, analysts and lawyers say.

Joint ventures are a popular choice because, unless a company has a controlling interest in one, it can keep details of it and the debt it acquires off its balance sheet.

“Almost all developers have disguised loans. The industry’s debt problem is worse than what you see,” said He Siwei, a lawyer at the Hui Ye law firm.

At the end of June, Chinese developers owed 33.5 trillion yuan ($ 5.24 trillion) through various channels, Nomura estimates, based on official statistics, adding that “there are certainly other obscure funding channels. yet to be covered “.

Private bonds issued by shell companies located abroad have become a new concern.

In a note this month, rating agency Fitch said Fantasia Holdings Group (1777.HK), a property developer that has since defaulted, recently told it “for the first time” that it owns 150 millions of dollars of private bonds that do not appear. have been declared in its financial statements.

Fantasia did not respond to a request for comment. The company had more than $ 4 billion in cash at the end of June and two weeks before its default it said it had “sufficient capital”.

Unsurprisingly, investors began to look in less obvious places as the most struggling companies in the industry were shut out of international capital markets.

According to an analysis by JPMorgan, some of the hardest hit developers had better finances than those whose bonds had been less impacted, underscoring a lack of confidence in the balance sheets.

Out of 70 Chinese real estate developers assessed by Moody’s, 27 have “significant” exposure to joint ventures, up from five out of 49 in 2015.

In a typical joint venture, a developer sets up a minority-owned real estate project with an asset manager or private equity fund and promises them fixed returns. The developer usually agrees to buy back their stake from the other investor after a certain number of years.

Chinese real estate stocks collapse


The escalation of Evergrande’s woes this year meant that his inability to make a bond payment last month was widely expected. Once the best-selling real estate developer in China, Evergrande has liabilities of more than $ 300 billion, which is equivalent to about 2% of China’s gross domestic product.

It was an illustration of the industry’s growth fueled by credit with debt that has almost quadrupled since 2016.

Evergrande’s funding model, which depended on a constant stream of new sales to fuel its operations, quickly ran into trouble when Beijing introduced its so-called “three red lines” rules last year that capped the amount of debt developers could take on compared to the amount of cash, assets, and equity they held.

Evergrande didn’t have many joint ventures, analysts said, but it used off-balance sheet debt for funding, such as the sale of wealth management products.

It also appears to have been exposed to corporate bonds, according to a list of bond conditions seen by Reuters.

JPMorgan analysts estimated that Evergrande’s true net indebtedness – a measure of a company’s financial leverage – was at least 177% at the end of June, compared to 100% reported in its accounts.

This is not the only one. JPMorgan estimated that R&F Properties’ leverage (2777.HK) fell from 123% to 139% after disguised debt was added, while Sunac China Holdings (1918.HK) figure fell from 87% to 138%. % to only cite a few. Read more

“I think no one knows for sure the true size of Evergrande’s debts,” said a bond regulator who declined to be identified.

Evergrande, R&F Properties and Sunac China did not respond to requests for comment.

The China Securities Regulatory Commission (CSRC), which overseas publishes disclosure by bond issuers, including developers, did not respond to a request for comment on the issue of hidden debt.

Hong Kong’s audit regulator said he was investigating Evergrande’s 2020 accounts and their audit by PwC because he had concerns about the adequacy of the reports. PwC has not commented on the announcement of the investigation.

The Chinese high-yield market has started to experience a timid recovery


China’s central bank governor Yi Gang said on Sunday that the Chinese economy faces failure risks for some companies due to “mismanagement” and that authorities will try to prevent the spread of problems in Evergrande.

At a press conference on Oct. 15, another central bank official said Evergrande was “an idiosyncratic risk” with limited ripple effects, urging developers to be responsible for paying off their debt.

Due to increased investor scrutiny, some Chinese developers have started to include some of their joint ventures on their balance sheets. In most cases, this leads to an increase in minority interests, according to a report released earlier this year by rating agency S&P Global.

Minority interests are viewed as equity rather than debt and, on paper, strengthen the financial strength of a business.

JPMorgan estimates Fantasia’s net indebtedness to be 92% when its joint ventures are included, compared to 76% reported. If you include both joint ventures and minority interests, that rises to 170%, the bank said.

The Fantasia default has sparked an industry-wide selloff, as Chinese high yield dollar corporate bond (.MERACYC) spreads have nearly tripled since late May.

But with the massive selling leaving prices low and yields available on some bonds now well above 200%, some investors have stepped down this week despite warnings of a treacherous trade.

“Absolutely, there are hidden risks,” said Jeff Grills, head of emerging market debt at Aegon Asset Management. “And the point is, it’s hard to know until you know it,”

($ 1 = 6.3915 yuan Chinese renminbi)

Additional reporting by Andrew Galbraith; Editing by Carmel Crimmins

Our standards: Thomson Reuters Trust Principles.

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