China’s Real Estate Developers: A grey rhino in the jungle of financial risks
Apart from the much-discussed trade war, the difficult financial situation of real estate developers is probably the most obvious grey rhino in China. While the risks have certainly been latent for quite some time, investors seem to have overlooked them. The recent deleveraging campaign has somewhat controlled leverage in state owned enterprises but unfortunately not yet in China’s highly leveraged private sector, of which real estate has the lion share. The question, though, is whether Chinese developers can handle the pressure of tougher financial conditions as loans may not be directed into the sector even with laxer monetary conditions. In this report, we aim to access their repayment ability to draw conclusions on the real estate sector with a bottom-up approach.
We argue that, even if demand for real estate remains resilient, the revenue of developers will be compressed from a decelerating price cycle driven by tighter regulations. In particular, the risk of further restrictions on housing prices, mortgage loans and land supply, especially in the first tier cities, will remain. Hence, developers are likely to be more cautious in land acquisition ahead of regulatory and liquidity risk, which could compress sales growth in the future.
Our concerns are on leverage and liquidity. Developers are increasingly reliant on advanced payments since their ability to borrow has waned. Beyond bank lending and bond issuance, the ability to raise capital is also constrained by a much less appealing equity market. Given the lack of financing means, developers have increased their offshore bond issuance since the beginning of 2018, even at a much higher funding cost, but the trend has ended in June.
We look at various parameters to access the repayment ability of Chinese developers, i.e. leverage ratio, liquidity risk, refinancing needs and forex exposure. Among the top 100 Chinese developers by asset size, we find that 13% are subjected to considerable repayment risk. Given the currently more adverse growth environment, notwithstanding the PBoC’s efforts to provide liquidity, concerns on the repayment ability of Chinese developers should be considered one of the largest grey rhinos of the Chinese economy. Still, we believe that the risk of default should be more limited to – relatively small – individual firms.
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