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Evergrande Allegations

June 21, 2012

I was quoted today by the BBC on today’s announcement that China will relax some of its restrictions on foreign investment in its domestic stock market.  You can read my comments here, and I’m also going to talk about it live on BBC TV at 6:30am Friday morning Beijing time (6:30pm Thursday NY time).

The big story today, in my opinion, is the report issued by Citron Research accusing Evergrande, one of China’s ten largest property developers, of massive fraud and arguing that the company is deeply insolvent and nearing the end of its rope.  I can’t vouch for any of the allegations, but the report is well worth reading.  Concerns about dodgy accounting practices have dogged Evergrande ever since its 2009 IPO, but Citron’s multi-barrelled shotgun blast takes them to an entirely new level, forcing the Hong Kong-listed company to issue an official denial today.

The allegations of rampant bribery and misuse of funds are certainly titillating, and do expose Evergrande to certain risks, but the really critical issue here is the company’s solvency and liquidity — whether it is a genuine going concern, or a house-of-cards Ponzi scheme.  Citron notes that Evergrande, which just this week shocked markets by paying a record-high RMB33k/sq meter auction bid for a plot of land in Guangzhou, has run a cumulative RM 26 billion operating (pre-Capex) cashflow deficit since 2006, sustaining itself by running up ever-rising levels of debt.  The report contends that Evergrande has hidden at least RMB 23 billion and possibly as much as RMB 56 billion in  trust loans and other debt off its balance sheet in Enron-style special purpose vehicles (SPVs).  It uses industry metrics to argue that Evergrande is overstating its cash balances by RMB 17 billion and overstating the value of its real estate holdings by RMB 10 billion.  Overall, its report argues that Evergrande is RMB 36 billion in the hole and fast running out of cash.

As I say, I’m not in a position to validate any of these specific allegations.  But they do resonate with me, because they resemble or are connected to many of the systemic risks I see building up across China’s property, trust, and banking sectors.  The big question I have been asking myself all Spring — with so much developer debt coming due, and with their cashflow so visibly impaired by the property downturn — is why we’ve hardly seen any Chinese developers (and the trusts that have fueled their building binge) go bust.  The hidden losses alleged by Citron may help answer that question, and the explanation is unlikely to be limited to one “bad actor.”  Like the losses that have been brushed under the rug in the Zhongdan Guarantee fiasco, they are just one piece in a much bigger and interconnected mosaic.

Here are some other data points and article links I’ve tweeted over the past few days @prchovanec:

  • (Jun 21) oughta be interesting RT @MalcolmMoore PLA, in internal corruption investigation, asks officers to reveal assets
  • (Jun 21) HSBC new export orders PMI sub-index drops to 45.9, lowest since March 2009
  • (Jun 21) Busnweek: In China’s Dating Scene, Women Get Pickier wow, tough market
  • (Jun 21) RT @ProfGillis PCAOB Warns China Patience is Wearing Thin – Compliance Week
  • (Jun 21) HSBC flash PMI for China falls to 48.1, 8th straight month of contraction, 7-month low
  • (Jun 21) Alchemy: AMCs regard property NPLs as “low risk” and have been booking large profits on spread btw promised returns and own borrowing
  • (Jun 21) Silent bailout? China’s AMCs have bought RMB 50b in troubled developer loans to keep real estate trusts from going bust
  • (Jun 21) Xi Jinping urges stronger Party grip over China’s top universities wonder what that means for the likes of me?
  • (Jun 21) Caixin: Rising alarms over food safety in China
  • (Jun 21) RT @BrookingsInst: @JonHuntsman, former Gov of Utah and Amb to China, joins Brookings as a distinguished fellow:
  • (Jun 21) RT @michaelmccrae Sinopec considers bid for Chesapeake assets
  • (Jun 21) @andrewserickson offers insight into China’s naval strategy and capabilities
  • (Jun 21) RT @AdamMinter Why are Chinese investors buying up Toledo real estate?
  • (Jun 21) China defends rare earth restrictions but they may be beside the point
  • (Jun 20) RT @theanalyst_hk $$ Australia’s inverted yield curve points to recession
  • (Jun 20) WSJ: Chinese gold imports skyrocketing
  • (Jun 20) China Banking Assoc says outstanding loans to “social housing” projects up 66% yoy
  • (Jun 20) PBOC survey: 15.1% of Chinese households plan to buy car in next 3 months, highest since survey began in 1999
  • (Jun 20) PBOC survey: 68.5% find housing prices “high and hard to accept,” +0.8% QoQ, -5.8% YoY
  • (Jun 20) PBOC survey: 20.4% expect housing prices to go up in Q3, +2.8% QoQ, -15.8% YoY
  • (Jun 20) PBOC survey: 15.7% of Chinese households intend to buy house in next 3 months, up 1.6% from 12-year low in Q1
  • (Jun 20) Is Germany looking bubbly, or just rebalancing?
  • (Jun 20) “Give us the dead body” – more on protest by African migrants in Guangzhou
  • (Jun 20) Censorship at SCMP? Is it even remotely ethical for new editor-in-chief to be CPPCC member?
  • (Jun 20) Cambodia arrests Frenchman linked to Bo Xilai, at Chinese request
  • (Jun 19) Foreigners take to Guangzhou streets to protest after African man dies in Chinese police custody
  • (Jun 19) Was China’s inflation imported from QE2? You decide:
  • (Jun 19) China steel industry assoc says revenues down 1%, profits down 97%, taxes paid down 58% YTD April
  • (Jun 19) 86% of South China factories saw orders fall or stay flat, but 90% are still struggling to hire enough workers
  • (Jun 19) WSJ: China turns to securitization to boost bank lending
  • (Jun 19) Official numbers show avg China home prices down 1.5%. This is discount everyone’s excited about? Either figures lie or buyers are nuts.
  • (Jun 19) Economic Observer reports steel, iron ore, coal, cement, and paper pulp piling up to record levels at China ports
  • (Jun 19) MOFCOM says FDI inflow into China up (tiny) 0.05% yoy after six straight months in negative territory – basically flat
  • (Jun 19) China Bsn News reports China’s domestic airlines lost RMB 1.4 billion in May
  • (Jun 19) China’s Ministry of Finance says state sector profits down 10.4% YTD by May, revenues up 11.3%
  • (Jun 19) China Securities Journal reports Beijing housing sales up 46.5% yoy in May
11 Comments leave one →
  1. Justin Knapp permalink
    June 21, 2012 8:13 pm

    This will be interesting to watch unfold. One minor item – consider replacing ‘titillating’ with ‘tantalizing’.

  2. Hua Qiao permalink
    June 21, 2012 9:18 pm

    The combination of poor financial analysis skills, a cultural hesitancy for low status analysts to ask powerful CFOs the hard questions and a penchant for covering up the sins of politically connected people has created a pressure cooker that is starting to blow. Auditing firms are useless. Even the Big 4 have no clout. Corporate governance is all a charade. The frauds and coverups are rampant. Misrecognition of revenue, hiding of expenses, capitalizing anything you can, falsifying invoices, tax receipts, appraisals, and just about anything else is rampant. If you want to see where bribes come from, go look at “office supply expense.”
    Real estate is just the start. Every industry has some of this. How come firms that are so “profitable” have such an insatiable appetite for debt? How come so few firms pay dividends? Don’t tell me it is growth opportunities that is the driver of ever increasing debt. No one is growing now. But as long as banks extend and pretend, the charade can continue for as long as depostits flow back into the banks. If there is anyone who seriously thinks that BASEL 2 and 3 put all Banks on an even playing field has never seen the egregious risk-less behavior of Chinese banks.

  3. June 21, 2012 9:39 pm

    “Evergrande”, very fitting name…

  4. June 22, 2012 5:25 am

    “wonder what that means for the likes of me?” Better brush up on those dialectical materialism skills… Seriously, you’ve been in China through what will be seen in hindsight as an amazing period in its history. It’s coming to an end though.

  5. Srinivasan Iyer permalink
    June 22, 2012 6:53 pm

    Dear Patrick,

    I write from India – we are witnessing similar situation here – real estate prices are going higher every month, esp. in Mumbai and Delhi – this is inspite of low or no sales ! I watched a program on the realty sector on TV yesterday, and lo and behold, all the respected experts were of the opinion that this was the best time to buy ….. no correction is expected, inflation is rising, land costs are rising, God does not create land anymore ….. all these reasons were to used to justify their positions.

  6. David permalink
    June 25, 2012 12:31 pm

    Dear Patrick,

    New York Times accuses the Chinese government of cooking the numbers.

  7. Hua Qiao permalink
    June 25, 2012 12:49 pm

    @ David,
    When they did the same thing in 1958/59, 40 million people died.


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