Chinese property debt is even higher than thought

Among the big questions for anxious investors in Chinese property bonds: How much debt do developers really have? Figuring that out may be far less easy than expected.

Case in point: struggling developer Kaisa’s surprise announcement last week that a wealth-management product it has guaranteed missed a payment. Shares and bonds of Kaisa plunged as a result. Some WMPs backed by Evergrande also failed to pay out on time in September, leading to protests. Such products aren’t necessarily directly issued by developers, but the companies may still be on the hook. And there are few details about them in their financial statements.

Beijing’s push for developers to comply with new leverage benchmarks called the “three red lines” since late last year may have driven companies to shift some debt into more unconventional channels. And such WMPs are far from the only problem.

Another way to obscure debt is through the use of joint ventures. It is common and legitimate to raise money and share risk by selling stakes in property projects to business partners. But the lack of transparency could leave investors guessing how much debt is actually stacked away. The debts of these JVs wouldn’t be included on a developer’s balance sheet if it only owns a minority stake. The developer may still, however, provide loan guarantees. Developers disclose such guarantees in the footnotes as contingent liabilities.

In a report published in June, S&P Global estimated there are 478 billion yuan, the equivalent of $75 billion, of such guarantees by rated Chinese developers, equal to around 9% of their reported debt. Borrowing and lending between JVs and developers further complicates the matter. The cash trapped in the JVs may also not be readily available to repay debt at the parent level.

But even for majority-owned JVs which are consolidated onto developers’ balance sheets, there are still chances to hide debt. For example, the developer may give the JV investors an option to sell their stakes back, which makes the equity very similar to debt in practice.

J.P. Morgan estimated in a report last month that Evergrande’s net debt-to-equity ratio would be 177%, instead of 100% as reported, if all such de facto debt—including commercial paper, wealth-management products and JV guarantees—were included. And, in fact, the actual leverage ratio could be even higher since evidence of some off-balance sheet debts may not be publicly available, the bank said.

Fears of hidden debt have sent bonds of developers that were previously considered safer plunging too. Country Garden’s dollar bonds due in 2022 have fallen to 90 cents on the dollar, according to FactSet. They were trading around par two weeks ago. The surprise default of Fantasia last month caused a bond-market panic since the developer seemed capable of repaying—at least on paper.

More such unwelcome surprises may be coming to light soon, especially since the housing market overall remains very sluggish and signs of a decisive shift in Beijing’s policy stance remain scarce.

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