Commentary on Political Economy

Wednesday, 2 September 2020


The Delicate Task of Dealing With China’s Most Debt-Burdened Property Giants

Reducing leverage may be good for the companies, but cash-starved local governments are desperately dependent on their land purchases

China’s central bank and housing ministry last month corralled developers to discuss lofty debt levels. PHOTO: THOMAS PETER/REUTERS
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Two of China’s most heavily leveraged developers are struggling in the stock market, and new attention from Beijing on their towering debt levels will put them under more pressure. But the central government’s efforts don’t address a key problem in the country’s economic model: Cash-starved local governments need indebted property developers to buy their land.

Shares in China Evergrande Group and Sunac China Holdings Ltd. are down 19% and 30% respectively this year. That partly reflects poor half-year results. In the first half of 2020, Evergrande’s net profits were cut nearly in half relative to the first six months of 2019, while Sunac’s grew by 6.5%, down from 57.1% year-over-year growth in 2019.

But the dismal stock performances also reflect new, unwelcome attention from Beijing: China’s central bank and housing ministry last month corralled developers to discuss lofty debt levels. According to state media, the meeting highlighted three “red lines” for developers to avoid: a liability to asset ratio of more than 70%, a net debt to equity ratio of over 100%, and cash to short-term debt ratio of less than 100%.

Evergrande and Sunac are the largest developers where debt metrics are worse than the reported redline level on every count.

What is perhaps most notable is that these poor debt metrics persisted this year even in the context of slowly growing or declining land banks. Evergrande’s land reserves declined by more than 50 million square meters in the first six months of the year, reaching a 3½ year low.

Sunac’s land bank is still growing, but at a far slower pace: The company’s land bank has increased by less than 6% since the end of 2019, to just shy of 250 million square meters. Between the end of 2015 and the end of 2019, the company bought land at a rapacious pace, its reserves of land growing by 750%.

On the one hand of course, that sounds like a positive thing. The companies are heavily indebted, so borrowing less to buy land seems like a good idea on the face of it.

But what’s good for the longer-term health of the companies may not be good for the system in general. Somebody needs to buy land from China’s local governments, with such sales making up around a third of their revenue. Since those municipalities shoulder most of China’s domestic government spending and remit taxes to Beijing, they cannot simply be starved of funds.

Sunac and Evergrande had been some of the largest purchasers of land in recent years. Without major changes to the Chinese fiscal framework, that burden will just be shuffled to other players.

Beijing’s focus on real estate makes it clear that the central government understands the threat that the sector’s leverage poses to China’s prosperity and stability. But it has yet to offer any meaningful incentives to improve the system: Merely telling Chinese developers they are too heavily indebted, when their voracious land purchases have been crucial to funding local governments, won’t work.

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