Clare Jim, Marc Jones, Samuel Shen

SHANGHAI/LONDON – The numbers don’t lie. You just have to look at the right ones.

Investors are looking for trouble spots in China’s real estate industry sector. China Evergrande Group, the largest Chinese company ever, is moving towards what could be China’s biggest-ever corporate default. Sometimes, the figures in the books don’t always tell the whole story.

Analysts and lawyers claim that many developers of real estate have turned to offbalance sheet vehicles since Beijing began to clamp down on corporate debt in 2017.

Because a joint venture is not controlled by a company, details about it as well as any debts it takes off the balance sheet are available.

Nearly every developer is insolvent. He Siwei, an attorney with Hui Ye Law Firm, said the sector’s problem with debt is more serious than you might think.

Nomura estimates that Chinese developers owed 33.5 Trillion Yuan ($5.24 TILLION) to various sources at the end June.

The issue of private bonds from offshore shell companies has become a major concern.

Fitch Ratings Agency stated this month that Fantasia Holdings Group (a property developer that has since defaulted) had just told them “for the very first time” it now had $150m in private bonds. These do not seem to have been included in Fitch’s financial statements.

Fantasia didn’t respond to our request for comment. At the end of June, it had more than $4 billion in cash. Two weeks earlier it stated that it had ample capital.

Investors are now beginning to seek out less visible places, as sectors with the highest levels of financial trouble have been barred from accessing international capital markets.

JPMorgan (NYSE) analysis revealed that some developers who were hardest hit had financials more appealing than others whose bonds had suffered less. This highlights a dearth of confidence in balance sheets.

Moody’s (NYSE) has rated 70 Chinese property developers. In 2015, five out of 49 had “significant” exposure.

A joint venture is where a developer creates a minority-owned property project and promises fixed returns. A developer typically agrees to purchase back its share from an investor after a specified period.

China property stocks come crashing down https://fingfx.thomsonreuters.com/gfx/mkt/znpnezndyvl/Pasted%20image%201634731447647.png

POSTERCHILD

Evergrande failed to pay its bond payments last month due to the escalation in Evergrande’s problems. Evergrande was once China’s largest property developer. It now has liabilities of over $300 billion, which is about 2% China’s gross domestic products.

The sector’s credit-fuelled boom was reflected in this image. It has a nearly quadrupled debt load since 2016.

Evergrande was dependent on constant flow of sales to finance its operations. Beijing’s “Three Red Lines” rules in 2011 put a cap on the amount that debt can be taken on top of the assets, cash and equity capital.

Analysts say Evergrande didn’t have any joint ventures but used off-balance sheets debt to fund its sales of wealth management products.

According to Reuters, the bond term sheet also suggests that it was exposed to private bonds.

JPMorgan analysts suggested that Evergrande had a true net gearing of at least 177% as of June. This is in contrast to its reported 100%.

But it is not the only one. JPMorgan estimated R&F Properties’ gearing jumped to 139% from 123% once disguised debt was added back on while Sunac China Holdings’ figure leapt to 138% from 87% to name just a few.

An anonymous bond regulator said that nobody knows the true size of Evergrande’s debt piles.

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

China Securities Regulatory Commission, which oversees overseas disclosure by bond issues, did not respond to a request of comment regarding the hidden debt issue.

Hong Kong’s auditor regulator said that it was investigating Evergrande 2020 accounts. PwC audited them because of concerns over the quality reporting. PwC didn’t comment on the news of the probe.

China’s high-yield markets were crushed by Evergrande worries https://fingfx.thomsonreuters.com/gfx/mkt/zdvxorkympx/Pasted%20image%201634731079441.png

MINORITY INTERESTS

Yi Gang, China’s central bank governor said Sunday that China’s economy is facing default risks due to certain companies’ “mismanagement” and that Evergrande will be a priority.

On Oct 15, another official from the central bank stated that Evergrande was “an idiosyncratic threat” with minimal spillover effects. He urged developers to repay their debt.

Some Chinese developers are now bringing some of the joint ventures into their balance sheets due to investor scrutiny. In most cases, that leads to a jump in minority interests, according to a report earlier this year by rating agency S&P Global (NYSE:).

A minority interest is considered equity, rather than debt. It can, in theory, increase a company’s financial strength.

JPMorgan projects that Fantasia’s net debt rises from 76% to 92% when joint ventures are added, to 92% for Fantasia. The bank stated that this rises to 170% if both minority and joint venture interests are considered.

Fantasia’s default led to a large sector sell-off with spreads for high-yield Chinese corporate dollars bonds more than tripling since late may.

Investors have continued to trade despite the warnings about a dangerous trade, despite the fact that prices are at an all-time low and yields for some bonds well below 200%.

Jeff Grills from Aegon Asset Management, who is responsible for emerging market debt, said that there were “absolutely hidden risks”. It is difficult to predict the future until it happens, ”

($1 = 6.3915 renminbi)