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Analysis: What’s underneath?Fear of hidden debt fosters China’s property problems

File Photo: On September 26, 2021, a signal can be seen near the headquarters of the China Ever Grande Group in Shenzhen, Guangdong Province, China.Reuters / Ally Song / File Photo

October 20, 2021

Samuel Shen, Mark Jones, Claire Jim

Shanghai / London (Reuters) – The numbers are not lies, you just have to look at the correct numbers.

This is a problem for investors looking for the following issues in China’s real estate sector: Industry giant China Ever Grande Group is heading towards what is expected to be the largest corporate default in China’s history. The numbers in the book sometimes do not tell the complete story.

Since Beijing began curbing corporate debt in 2017, many real estate developers have turned to borrow money to use off-balance-sheet debt to avoid regulatory oversight, according to analysts and lawyers. became.

Joint ventures are a popular option because they can remove their details and acquired debt from the balance sheet unless the company has control of it.

“Almost all developers are in disguise and are in debt. The debt problem in this sector is worse than what you see,” said He Siway, a lawyer at Huye Law Firm. ..

Nomura estimates that Chinese developers owe 33.5 trillion yuan ($ 5.24 trillion) through various channels at the end of June, based on official statistics, saying, “There are other ambiguous funding channels that are not yet covered. There is no doubt about that, “he added.

Private bonds issued by offshore shell companies have emerged as a new concern.

In this month’s memo, Fitch’s rating agency said the defaulting real estate developer, Fantasia Holdings Group, recently said it had “for the first time” a $ 150 million private bond. .. Its financial statements.

Fantasia did not respond to requests for comment. The company said it had “sufficient capital” at the end of June and two weeks before the default, with over $ 4 billion in cash.

Not surprisingly, investors are starting to look less prominent as the sector’s most problematic companies are locked out of the international capital markets.

According to JPMorgan’s analysis, some of the hardest hit developers have a better financial appearance than those with less bond impact, highlighting their lack of confidence in their balance sheets.

Twenty-seven of the 70 Chinese real estate developers rated by Moody’s have “significant” exposure to the joint venture, compared to five out of 49 in 2015.

In a typical joint venture, a developer launches a minority-owned real estate project with an asset management company or private equity fund, promising fixed income. Developers usually agree to buy back shares from other investors after a certain number of years.

Chinese real estate stocks plunge https://fingfx.thomsonreuters.com/gfx/mkt/znpnezndyvl/Pasted%20image%201634731447647.png

Poster child

The escalation of this year’s Evergrande issue meant that last month’s bond payment failures were highly anticipated. Once the best-selling real estate developer in China, Evergrande has a debt of over $ 300 billion, which is about 2% of China’s gross domestic product.

It was a credit-backed growth descendant of the sector, with a pile of debt that has nearly quadrupled since 2016.

Evergrande’s funding model relied on a constant stream of new sales to supply its business, but last year Beijing limited the amount of debt developers could assume, the so-called “Three Red Lines.” When I introduced the rules, I immediately ran into a problem. The amount of cash, assets, and equity that they held.

According to analysts, Evergrande did not have many joint ventures, but used off-balance-sheet debt to raise funds, such as selling asset-managed products.

According to the bond term sheet that Reuters saw, it also seemed to have exposure to private bonds.

JPMorgan analysts estimated Evergrande’s true net gearing (a measure of a company’s financial leverage) to be at least 177% at the end of June, compared to the 100% reported in the account.

Not only that. JP Morgan estimates that with the addition of counterfeit debt, gearing in R & F properties jumped from 123% to 139% and Sunac China Holdings figures jumped from 87% to 138%.

“I don’t think everyone knows for sure the actual size of Evergrande’s debt,” said bond regulators who refused to identify.

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

The China Securities Regulatory Commission (CSRC) did not respond to requests for comment on debt issues with hidden foreign disclosures by bond issuers, including developers.

Hong Kong’s audit regulator said it was investigating Evergrande’s 2020 accounting and PwC audits because it was concerned about the adequacy of the report. PwC did not comment on the announcement of the probe.

China’s high-yield market has been crushed by Evergrande concerns https://fingfx.thomsonreuters.com/gfx/mkt/zdvxorkympx/Pasted%20image%201634731079441.png

Minority interest

China’s central bank governor Yi Gang said on Sunday that the Chinese economy is facing the risk of default for certain companies due to “mismanagement” and authorities will strive to prevent the Evergrande problem from spreading. ..

At a press conference on October 15, another central bank official said Evergrande was a “unique risk” with limited spillover and urged developers to take responsibility for debt repayment.

With increased investor scrutiny, some Chinese developers have begun incorporating some of their joint ventures into their balance sheets. According to a report earlier this year by rating agency S & P Global, in most cases it will lead to a surge in minority interests.

Minority interests are considered equity rather than liabilities and, on paper, enhance a company’s financial strength.

JPMorgan estimates that Fantasia’s net gearing will rise to 92%, including joint ventures, but only 76% have been reported. However, including both the joint venture and minority interests, the bank said it would rise to 170%.

Fantasia defaults have prompted the sector to sell out, with China’s high-yield corporate bond spreads nearly tripled since late May.

However, some investors have said this week, despite warnings of dangerous deals, as large sells have bottomed out and yields available on some bonds are now well above 200%. I’m pulling my leg.

“There are absolutely hidden risks,” said Jeff Grilles, Head of Emerging Markets Debt at Aegon Asset Management. “And the problem is that it’s hard to know until you know.”

($ 1 = 6.3915 Chinese RMB)

(Additional report by Andrew Galbraith; edited by Carmel Crimmins)



Analysis: What’s underneath?Fear of hidden debt fosters China’s property problems

Source link Analysis: What’s underneath?Fear of hidden debt fosters China’s property problems

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