Analysis: What lies beneath? Hidden debt fears feed China's property woes

Modern Land (China)

21/10/2021 24:00

* Investors don't trust Chinese property developers'
accounts
    * Private bonds emerge as new concern
    * Real estate sector debt problem bigger than it
looks-analysts
    * China's central bank has said economy faces default risks 

    By Samuel Shen, Marc Jones and Clare Jim
    SHANGHAI/LONDON, Oct 21 (Reuters) - Numbers don't lie, you
just need to be looking at the right ones.
    That's the problem for investors searching for the next
trouble spot in the Chinese real estate sector as industry giant
China Evergrande Group  3333.HK  lumbers https://www.reuters.com/business/china-protect-legal-rights-evergrande-creditors-cbank-head-2021-10-20
 towards what is expected to be the country's largest-ever
corporate default. The figures on the books sometimes don't tell
the full story.
    Since Beijing started clamping down on corporate debt in
2017, many real estate developers have turned to
off-balance-sheet vehicles to borrow money and skirt regulatory
scrutiny, analysts and lawyers say.
    Joint ventures are a popular choice because, unless a
company holds a controlling interest in one, it can keep details
of it and the debt it acquires off its balance sheet.
    "Nearly every developer has borrowings in disguise. The
sector's debt problem is worse than what you see," said He
Siwei, attorney at Hui Ye Law Firm.
    Chinese developers owed 33.5 trillion yuan ($5.24
trillion)through various channels at the end of June, Nomura
estimates, based on official statistics, adding "there are
definitely other obscure financing channels yet to be covered."
    Private bonds issued by shell companies in offshore
locations have emerged as a new concern.
    In a note this month, Fitch ratings agency said that
Fantasia Holdings Group  1777.HK , a property developer which
has since defaulted, had recently told it "for the first time"
that it had $150 million of private bonds that do not appear to
have been reported in its financial statements.
    Fantasia did not respond to a request for comment. The
company had over $4 billion worth of cash at the end of June and
two weeks before it defaulted said that it had "ample capital".
    Unsurprisingly, investors have begun to look in less obvious
places as the sectors' most troubled firms have been locked out
of international capital markets.
    Some of those developers hit hardest had better-looking
financials than those whose bonds had been less impacted,
according to an analysis by JPMorgan, underlining a lack of
faith in balance sheets.
    Out of 70 Chinese property developers rated by Moody's, 27
have "significant" exposure to joint ventures, compared with
five out of 49 in 2015.
    Under 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 its stake from the other
investor after a certain number of years.
    
    POSTERCHILD
    This year's escalation of Evergrande's woes meant that its
failure to make a bond payment last month was largely expected.
Once China's top-selling property developer, Evergrande has over
$300 billion in liabilities, equivalent to about 2% of China's
gross domestic product. 
    It was the posterchild for the sector's credit-fuelled
growth with a debt pile that has nearly quadrupled since 2016.
    Evergrande's financing model, which depended on a constant
stream of new sales to feed 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
capital they held.
    Evergrande did not have many joint ventures, analysts say
but it did use off-balance sheet debt for funding, such as sales
of wealth management products.
    It also appears to have had exposure to private bonds,
according to a bond term sheet seen by Reuters.    
    JPMorgan analysts estimated that Evergrande's true net
gearing -- a measure of a company's financial leverage -- was at
least 177% at the end of June, compared to the 100% reported in
its accounts.  
    It is not the only one. JPMorgan estimated R&F Properties'
 2777.HK  gearing jumped to 139% from 123% once disguised debt
was added back on while Sunac China Holdings'  1918.HK  figure
leapt to 138% from 87% to name just a few.  urn:newsml:reuters.com:*:nL1N2R31W7
    "I don't think anyone knows for sure the real size of
Evergrande's debt piles," 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 disclosure by bond issuers, including developers,
didn't respond to a request for comment on the issue of hidden
debt.
    Hong Kong's audit regulator has said it is investigating
Evergrande's 2020 accounts and their audit by PwC because it had
concerns about the adequacy of reporting. PwC did not comment on
the announcement of the probe.  urn:newsml:reuters.com:*:nL1N2RB1VW
    
    MINORITY INTERESTS
    China's central bank governor Yi Gang said on Sunday that
China's economy faces default risks for certain firms due to
"mismanagement", and that authorities will try to prevent
problems at Evergrande from spreading. 
    In a press conference on Oct 15, another central bank
official said that Evergrande is "an idiosyncratic risk" with
limited spillover effects, urging developers to be responsible
for repaying their debt. 
    Due to increased investor scrutiny, some Chinese developers
have started to bring some of their joint ventures onto their
balance sheets. In most cases, that leads to a jump in minority
interests, according to a report earlier this year by rating
agency S&P Global.
    Minority interests are considered equity rather than debt
and, on paper, boost a company's financial strength.
    JPMorgan estimates that Fantasia's net gearing rises to 92%
when its joint ventures are included compared to a reported 76%.
If both joint venture and minority interests are included,
however, that rises to 170%, the bank said.
    Fantasia's default prompted a sector-wide sell-off, with
spreads on Chinese high-yield corporate dollar bonds  .MERACYC 
nearly tripling since late May.
    But with the mass sell-off leaving prices at rock bottom and
the yields available on some of the bonds now well over 200%,
some investors have been dipping their toes back in 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
thing is it is hard to know until you know," 
($1 = 6.3915 Chinese yuan renminbi)

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
China's high-yield markets were crushed by Evergrande worries   
 https://tmsnrt.rs/3C04Cgq
China property stocks come crashing down    https://tmsnrt.rs/3plzkx8
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 (Additional reporting by Andrew Galbraith; Editing by Carmel
Crimmins)
 ((samuel.shen@thomsonreuters.com;  +86 21 20830018; Reuters
Messaging: samuel.shen.thomsonreuters.com@reuters.net))