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Shanghai/London – Numbers don’t lie, you just need to look for the right people.

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That’s a problem for investors looking for the next crisis in the Chinese real estate sector as industry giant China Evergrande Group is expected to be the country’s biggest corporate default. Figures in books sometimes don’t tell the whole story.

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Analysts and lawyers say that ever since Beijing began tightening the noose on corporate debt in 2017, many real estate developers have turned to off-balance-sheet vehicles to borrow money and avoid regulatory scrutiny.

Beyond Evergrande, China’s property market faces a $5 trillion reckoning

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Joint ventures are a popular option, because as long as a company doesn’t have a controlling interest in one, it can keep a description of it and the debt it receives from its balance sheet.

“Almost every developer has spoofed credit. The sector’s debt problem is worse than what you see,” said He Siwei, attorney at the Hui Ye law firm.

Nomura, based on official data, estimates that Chinese developers are owed 33.5 trillion yuan ($5.24 trillion) through various channels at the end of June, adding “of course there are other unclear 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, a property developer that has since defaulted, recently told it “for the first time” that it had $150 million in private bonds worth $150 million. does not appear to have been reported. its financial statements.

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

Unsurprisingly, investors have begun to look in less obvious places as the sector’s most troubled firms have been forced out of international capital markets.

Some of those developers had the toughest financial performance, whose bonds were less affected, according to an analysis by JPMorgan, underscoring the lack of confidence in the balance sheet.

Evergrande says six executives have refunded money from advance redemption of products

Of the 70 Chinese property developers assessed by Moody’s, 27 have “significant” exposure to joint ventures, compared to five out of 49 in 2015.

Under a typical joint venture, a developer sets up a minority-owned real estate project with a property manager or private equity fund and promises them a fixed return. The developer usually agrees to buy back his stake from another investor after a few years.

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The escalation of Evergrande’s crisis this year meant that its failure to make bond payments last month was largely expected. Evergrande, once China’s best-selling property developer, has more than $300 billion in liabilities, equivalent to about 2% of China’s GDP.

It was the posterchild for the sector’s credit-fuelled growth with debt piling up that has nearly quadrupled since 2016.

Evergrande’s financing model, which relied on a constant stream of new sales to feed its operations, quickly ran into trouble when Beijing last year introduced its so-called “Three Red Lines” rules, which amount to debt developers. than could have taken. The amount of cash, assets and equity capital held by them.

Analysts say Evergrande didn’t have many joint ventures, but it did use off-balance sheet debt to fund such as the sale of wealth management products.

It appears to have also been exposed to private bonds, according to a bond term sheet seen by Reuters.

Analysts at JPMorgan estimated Evergrande’s real net gearing — a measure of a company’s financial leverage — at the end of June was at least 177%, compared to 100% of its accounts reported.

It’s not the only one. JPMorgan estimates R&F Properties’ gearing to rise from 123% to 139% once hidden debt is added back, while Sunak China Holdings’ figure rises from 87% to 138%, to name just a few. .

“I don’t think anyone knows for sure the actual size of Evergrande’s debt pile,” a bond regulator said on the condition of anonymity.

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

The China Securities Regulatory Commission (CSRC), which was disclosed by bond issuers overseas, including developers, did not respond to a request for comment on the issue of hidden debt.

Evergreen creditors fear imminent default as area of ​​concern

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 investigation.

minority interests

China’s central bank governor Yi Gang said on Sunday that China’s economy faces default risk for some firms due to “mismanagement”, and officials will try to stop problems at Evergrande from spreading.

At a press conference on October 15, another central bank official said Evergrande is “a specific risk” with limited spillover effects, urging developers to be responsible for repaying their debt.

Due to increased scrutiny from investors, some Chinese developers have started bringing some of their joint ventures on their balance sheets. According to a report by rating agency S&P Global earlier this year, in most cases, this leads to a surge in minority interests.

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 76%. If both the joint venture and minority interest are included, however, this rises to 170%, the bank said.

Fantasia’s default prompted a sector-wide sell-off, with the spread on Chinese high-yield corporate dollar bonds nearly tripling since late May.

But with a massive sell-off with prices at rock bottom and available yields on some bonds now exceeding 200%, some investors are back on their toes this week despite warnings of a treacherous trade.

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

($1 = 6.3915 Chinese Yuan Renminbi)