Chinese developers remain mired in debt even after financial lifeline

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As millions of Chinese headed home last week to celebrate the Lunar New Year, Michael Lin had to break the bad news to his 7-year-old daughter: she would not be seeing her grandparents in Anhui province during the long holiday week.

Lin, who runs a painting and heating-insulation company in neighbouring Jiangsu province, had to sell the family’s 2017 Honda SUV last December to keep his small business – and six employees – afloat.

He is one of the thousands of suppliers who have had to forgo holidays, tap into rainy-day funds or close their businesses in the past year, as they too came into hard times, following the outsize debts owed by China Evergrande Group, Kaisa Group Holdings and dozens of Chinese developers facing US$84 billion of bond payments in 2022.

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“No money, no new year,” said Lin, whose company is owed more than 5 million yuan (US$790 million) in overdue payments by Evergrande.

The struggles of China’s developers to make good on IOUs to suppliers and a suffocating amount of debt owed to bondholders – both onshore and offshore – have presented a troubling conundrum for China’s government. Does the government step in to support the severely overleveraged housing industry, to boost the nation’s economy after a years-long campaign to cut private debt?

A recent series of policy decisions – including the first cut to a lending rate that underlies most mortgages in nearly two years – signalled the government’s willingness to support an industry that accounts for a quarter of the gross domestic product (GDP), which has been buckling under tight borrowing constraints in the past 18 months, analysts said.

Sources: Northeast Securities, Tianfeng Securities, company reports. SCMP Graphics alt=Sources: Northeast Securities, Tianfeng Securities, company reports. SCMP Graphics>

It also hearkens back to seven years ago when the government stepped in to save the housing market as the nation’s economy grew at its slowest pace in a quarter century.

Reducing the five-year loan prime rate (LPR) – a reference rate for mortgages – by a modest 0.05 per cent to 4.6 per cent on January 20 was a “significant signal” the Chinese government is preparing to loosen its property policies, according to Goldman Sachs.

That followed cuts in the one-year LPR – on which most new and outstanding loans are based – in both December and January and a cut in the required reserve ratio (RRR) for banks in December.

“The property sector, arguably the most important sector in the Chinese economy, has been in deep negative territory for six months now,” Goldman’s economists Hui Shan and Maggie Wei said in a note. “After improving in October and November on relaxation in bank lending, mortgage loans dipped again in December, suggesting the weakness in the property sector may be spreading from credit constraints to deteriorating household expectations and purchase demand.”

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A shaky property market on top of weaker consumption driven by a resurgent Covid-19 pandemic has increased the urgency for policymakers to “reverse the downward trajectory” seen at the turn of the year, Goldman said.

Authorities will seek to avoid a “hard landing” this year with additional incremental easing, but are likely to stick to their goals of deleveraging the industry over the medium to long-term, RBC Wealth Management’s analysts Frederique Carrier and Jasmine Duan said.

“As a result, the property market slowdown is likely to continue in the first half of the year and weigh on economic growth,” they said in a note.

A man passes by a sign in Beijing depicting Evergrande Group’s operations in China Photo: AP alt=A man passes by a sign in Beijing depicting Evergrande Group’s operations in China Photo: AP>

Home sales in China’s US$1.7 trillion housing market are expected to decline by as much as 10 per cent this year after rising about 3 per cent in 2021. That could mean more pain for big developers like Evergrande and small suppliers like Lin.

Lin took out loans last year to avoid laying off his employees, but may have to cut loose two or three workers after the Lunar New Year holiday if Evergrande does not pay him, he said.

“If the property sector continues to be dormant like this, even if Evergrande gave me back my money, the business won’t stay the course, as [there will be] not enough new walls for us to paint,” Lin said.

The drag on the Chinese economy by the property sector has been brewing for years as developers, such as Evergrande, borrowed aggressively to expand beyond their core property business into everything from electric vehicles to bottled water.

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In August 2020, Beijing implemented its “three red lines” rules, which limited the amount of bank loans overleveraged developers could borrow, cutting off the industry’s funding and driving some developers to the brink of bankruptcy.

Evergrande, based in Guangzhou, has US$4.4 billion in principal and interest payments due on its offshore debt by the end of June. That is in addition to billions of dollars in domestic bonds and IOUs to its mainland suppliers that are set to come due by the end of June.

As of last June, Evergrande, the world’s most indebted developer, had more than US$300 billion in total liabilities, including some US$100 billion owed to its suppliers in the construction, furnishings and materials sectors.

On January 24, the company pleaded with offshore creditors for more time to tackle its “increasingly complex” financial situation after international bondholders threatened last month to “seriously consider enforcement actions” against Evergrande, saying the developer had failed to properly engage with them on its restructuring efforts.

Evergrande is one of several developers, including Fantasia Holdings, Modern Land (China) and Kaisa, who have defaulted on their offshore debt as they have faced cash crunches in recent months.

Unfinished apartment buildings at an Evergrande development in Beijing. Photo: Bloomberg alt=Unfinished apartment buildings at an Evergrande development in Beijing. Photo: Bloomberg>

And the list is getting longer. Just one month into 2022, China Aoyuan Group and Yuzhou Group said they cannot pay their US dollar notes.

The contagion even extended to some developers once regarded as sound and restrained. Shimao Group Holdings and Country Garden Group, both tagged as “green” under the government’s lending limits – indicating that they had been in compliance with debt limits – have had their bonds and shares dumped by panicked investors concerned about their financial liquidity.

As much as US$84 billion of debt issued by China’s property developers are due to mature in 2022, and a third of them could see their liquidity “acutely strained” in the worst-case scenario, according to S&P Global Ratings.

Sources: Evergrande, SCMP Research. SCMP Graphics alt=Sources: Evergrande, SCMP Research. SCMP Graphics>

The move by policymakers in Beijing to cut rates could provide some needed breathing room for the property sector, particularly if it resurrects stagnant home sales.

It also presents an acute contrast to other major economies where fears over sharp rises in inflation in recent months have forced policymakers to consider rate hikes.

The Bank of England increased its benchmark interest rate in December for the first time since the beginning of the coronavirus pandemic and raised rates again on Thursday. Inflation in the United Kingdom hit its highest level in almost 30 years at 5.4 per cent in December.

The US Federal Reserve is expected to raise rates as soon as March, with the nation’s inflation rate topping 7 per cent last month.

“Some of the recent moves made by Beijing are similar to what it did in 2015,” said Tommy Wu, lead China economist of Oxford Economics in Hong Kong. “Some easing policies, which have been awaited ever since Evergrande failed, are now expected to roll out soon to avoid more developers falling one by one.”

In 2015, China’s economy had slowed to a 6.9 per cent growth rate – its slowest in 25 years – roiling the stock market and wiping out an estimated US$5 trillion in value. Kaisa became the first Chinese developer to ever default on its US dollar debt in April 2015.

A Kaisa sign at the Shanghai Kaisa Financial Centre in Shanghai. Photo: Reuters alt=A Kaisa sign at the Shanghai Kaisa Financial Centre in Shanghai. Photo: Reuters>

Over three weeks in June of that year, the Shanghai Composite Index fell by 30 per cent and more than of the 1,400 companies listed in Shanghai asked to halt trading of their shares to avoid further losses.

A U-turn only came after the People’s Bank of China (PBOC) decided to cut both its benchmark lending and deposit rates in June in a move to boost market liquidity.

China’s new home prices surged for six straight years until last September, creating some of the country’s wealthiest people, including Evergrande’s Hui Ka-yan and Country Garden’s Yeung Kwok-keung.

With the latest rate cuts and additional help expected for the property sector, will private developers be able to move past their recent troubles and once again become a sweetheart of investors?

The answer is so far unclear, but some of the moves suggest that state-owned companies will play a bigger role in the property sector and take a larger share of home sales, rather than private companies.

Rate cuts are not the only tool Chinese authorities appear to be deploying to help ease some of the strain on developers: state-owned enterprises buying assets from cash-strapped players.

Last week, Agile Group, one of the country’s top 20 home sellers, said it would sell its 26.7 per cent stake in a Guangzhou property joint venture for 1.84 billion yuan to a unit of China Overseas Land & Investment.

Is Evergrande too big to fail?

That followed Shimao agreeing to sell land in Shanghai to a company owned by the municipal government.

Meanwhile, state-owned China Resources Land has signed an agreement to borrow 23 billion yuan from China Merchants Bank to finance property acquisitions on January 27.

“Leading developers (largely state-controlled) are being encouraged to buy assets from weaker players, with cheap credit provided by banks; and, crucially, the debt accrued in purchases is exempt from the ‘three red lines’,” said Rory Green, TS Lombard’s chief China economist.

“Although funding conditions are easing and sales showing signs of stabilisation, more defaults are all but guaranteed and property investment has further to fall: we think property [fixed asset investment] will contract 5 per cent in 2022. Ergo: the sector will remain a large drag on economic activity,” he added.

SCMP Graphics alt=SCMP Graphics>

Another lingering question for developers and international bondholders alike is how far Beijing is willing to go to support the property sector, given President Xi Jinping’s determined attempt to overhaul the residential real estate market, and achieve his common prosperity objective.

Since Xi’s 2016 edict that “houses are for living in, not for speculation”, several rounds of cooling measures have been rolled out across the country, including caps on home and land prices and restrictions on resales.

Last year, China’s central government authorised the expansion of a property tax trial in additional cities beyond Shanghai and Chongqing, but the timing of the expansion remains in limbo.

During the Central Economic Work Conference last December, the mantra of “houses are for living in, not for speculation,” was highlighted again, showing Xi’s determination to tame runaway home prices.

“The government’s pivot away from a property-reliant economy is being tested as economic growth is slowing down, and more developers are failing,” said Yan Yuejin, director of Shanghai-based E-house China Research and Development Institute. “We may see more loosening up over the sector, but we may not see any private companies expand like they did in 2015.”

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP’s Facebook and Twitter pages. Copyright © 2022 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2022. South China Morning Post Publishers Ltd. All rights reserved.





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