Major Chinese developers have delayed declaring their annual audited results for 2021. Now investors are worried this means they have deeper hidden problems in their businesses and will struggle to repay debts.
On the other hand, the hold-up could provide investors with more clarity about which developers are more likely to make it through the crisis with little further damage.
Earnings season should have just finished for Hong Kong-listed Chinese developers due to announce their annual results by March 31. However, at least 10 missed the deadline and the Hong Kong stock exchange reacted by suspending their shares.
Developers, including China Evergrande Group, Kaisa, Ronshine China, Shimao Group, and Guangzhou R&F Properties, blamed the Omicron outbreak across major cities in China for the delay.
For example, Shanghai is going through a city-wide lockdown at the moment while Shenzhen just came out of one.
It may not have been the only, or even the chief, reason, however. Ahead of the March 31 deadline, EY and PwC, two largest auditing firms for listed Chinese developers, resigned from auditing several large Chinese developers, while some other developers replaced their auditors halfway, in some cases with smaller and less reputable firms.
“Disputes with auditors over accounts and extra time involved in auditor replacement are the more plausible reasons for the delays, which hinted at the level of distress in these developers,” said Xu Tianchen, China economist at the Economist Intelligence Unit (EIU).
PwC declined to comment on client matters.
“A more important factor in the delay could be a lack of transparency for those developers, especially with regards to their off-balance-sheet debt, which would complicate the process for accounting. Developers who missed the March 31 deadline for audited results are those with bigger debt problems which could require stricter scrutiny from the auditors,” said Kristy Hung, senior analyst for China property at Bloomberg Intelligence.
“For investors, the absence of financial results is not a good sign, especially if it is caused by the resignations of auditors. It can be a bigger worry for bond investors concerned about potential defaults than the equity investors betting on a rebound,” said Gary Ng, senior economist at Natixis CIB.
“The delayed audited results reflect the ongoing trend of credit polarisation, meaning the best is better and the worst is worse. Even though regulators have slightly relaxed the policies and the monetary policies can be laxer, it is unlikely that liquidity will rain on the high-leverage developers, which is the core of the current problem,” Ng said.
“Investors may hold a more pessimistic view of their corporate governance, transparency, and liquidity conditions for firms that cannot publish their financial statements timely,” he added.
According to EIU data, Chinese developers are due to repay more than 1 trillion yuan ($157 billion) of debt this year, including dollar bonds, domestic bonds, and supply chain financing.
Third Bridge, an investment research firm, predicts real estate investment growth will continue to decline in China until the end of 2022 or even July 2023. Real estate sales, generally a leading indicator of investment seven to eight months in advance, are falling across China now, noted Li Hemin, analyst at Third Bridge.
“Our experts think that there will properly be more real estate enterprises that default on their loans, especially during the first half of 2022,” Li said.
Rating agencies including Moody’s and Fitch Ratings said in recent reports that the delay in filing audited results is credit negative for these developers, as it raises concerns over corporate governance and financial transparency, particularly if associated with an auditing firm resigning or being sacked close to reporting deadlines.
“Failure to issue audited results will continue to leave investors in the dark, at a time when working out the two key variables - how much cash and debt the developers have on hand - is critical to assessing their liquidity and solvency and therefore the pricing of their bonds and equities,” said Kristy Hung, senior analyst for China property at Bloomberg Intelligence.
The halt in the stock trading will further block developers' path to equity raising, Hung noted.
Bloomberg expects a 40-50% contracted sales slump for top 100 Chinese developers could extend through mid-year, driven by a high base of last year as well as weakening demand and supply.
REGULATIONS STILL KEY
Principal Real Estate Investors
Since the fourth quarter of last year, the government in Beijing has relaxed regulations for the real estate sector, such as easing the flow of credit to developers in debt crisis. A few Chinese cities have also tried to boost demand recently by relaxing purchase and loan restrictions for homebuyers.
“The base effects could become more favourable in the second half of the year. By then, the impact of the stepped-up easing measures that are starting to come through should be felt more clearly and there should also be more clarity as to which developers are likely to be able to make it through this crisis unscathed. In sum, there is scope to turn more constructive in the second half of the year although the near-term outlook remains murky,” said Shern-Ling Koh, portfolio manager at Principal Real Estate Investors.
“These are not unsurprising given the pressure the sector has been under and is likely well understood and priced by the market by now,” Koh noted.
"Investors should watch for how some of the debt restructurings or exchanges will be structured, especially the differences between onshore and offshore debt restructurings as this could create a permanent risk premium around the ability of Chinese property developers to tap offshore bond markets if the differences are too stark," he said.
Additionally, progress on the just announced financial stability fund in helping to backstop systemic risk is worth monitoring too, he added.
On April 6, the People's Bank of China released a draft law on financial stability to establish a financial stability fund and a cooperation system across different financial regulators and local governments to manage the country's financial risks.
The market would also be keeping a close eye on the role of state-owned enterprises, asset management companies, and insurers to see if they take a more active role in purchasing assets and assisting in restructuring some of these distressed developers, said Bloomberg’s Hung.
The authorities could also announce targeted measures to improve the source of financing for certain developers, such as bank lending or even the reopening of bond sales; and developers' access to pre-sale proceeds tied up in escrow accounts, she added.