What One of China’s Biggest Property Companies Can Tell Us About Debt

If you want to avoid being seen to cross any red lines, you could simply go dark.

China’s authorities have introduced the “ three red lines” targets as a way of trying to encourage the country’s vast real estate sector to deleverage. Companies who don’t meet the required thresholds under the new program — such as a 70% ceiling on the ratio of liabilities to assets — will have their growth restricted.

While there are many ways of minimizing the appearance of debt on one’s balance sheet — including through so-called minority interests — one of the country’s biggest property developers after China Evergrande Group appears to have struck on an unusual approach, according to analysts at CreditSights Inc.

Sunac China Holdings Ltd, a Hong Kong-listed real estate firm that’s based in mainland China, has stopped breaking out a particular type of financing instrument in its earnings reports.

“We note that the notes payable amounting to RMB 22.8 billion as of 31 December 2020, which was previously disclosed in Sunac’s FY20 annual report and contained bank acceptance bills, was subsequently subsumed under trade payables in 1H21,” write CreditSights analysts Luther Chai and Cheong Yin Chin in a note titled ‘Sunac China: Hide-and-Seek’ and published this week.

Faced with questions from the analysts earlier this year, Sunac had clarified to them that “notes payable” included bank acceptance bills, a type of short-term instrument that the company uses to make payments to its suppliers. The amount of such notes on Sunac’s balance sheets had more than doubled between the end of 2019 and 2020, mirroring a broader increase in use of these kinds of trade receivables across Chinese real estate firms under pressure to deleverage.

Such notes aren’t included under debt-to-equity ratios used to calculate whether the company meets its red lines commitments, but analysts can nevertheless follow the upward trajectory and ask questions about the degree to which Chinese firms are actually deleveraging. CreditSights said earlier this year that it had confirmed with Sunac that notes payable aren’t interest-bearing, and therefore are not classified as debt.

But what was once a concerning trend at Sunac has now disappeared from its official statements altogether, absorbed under the overall ‘trade payables’ bucket. Sunac’s official total debt remained flat in the first half of the year at 304.3 billion yuan, according to CreditSights.

An email sent to Sunac wasn’t immediately returned.

Meanwhile, the company’s use of minority interests — another accounting practice that has prompted questions from analysts this year — appears to be rising. CreditSights’ numbers indicate the proportion of minority interests as total equity reached 38% in the first-half of this year at Sunac, compared with just 9% at the end of 2016. Such minority interests typically involve companies spreading their financial commitments through partnerships, allowing them to hold minority interests that can be considered equity instead of yet another liability.

A report from S&P Global Ratings published in June estimated minority interests as a percentage of total equity across China’s real estate development companies had jumped from a median 14% in 2015 to 39% in 2020.

“Information transparency is a key issue and it's getting worse,” wrote S&P analysts led by Edward Chan. “Often times these project entities are unconsolidated and sit off-balance sheet. Hence, most companies don't provide much disclosure, let alone audited figures. This leaves room for dressing up financials.”

Related links:
Transcript: Understanding Evergrande, the Troubled Chinese Real Estate Giant
China's property developers seek to dodge new rules with shift of debt off balance sheets