One-Third Of China’s Real Estate Companies Are Debt Zombies

As China’s economy continues to sputter, many local companies are having difficulty servicing their debts. A look at 3,000 listed Chinese businesses by French investment bank Natixis found that interest costs exceeded cash flow for 18.5% of them last year, compared with 8% in 2010.

Real estate, the most debt-ridden sector, saw its leverage level reach 197% last year, nearly double the figure for 2008, according to Natixis. The investment bank estimates that almost one-third of listed companies in the sector are “zombies” — businesses that are on the brink of default but still taking on more debt.

“The share of zombies in the real estate sector literally doubles the average in [corporate] China,” said Iris Pang, senior economist for greater China at Natixis. Evergrande Real Estate, for example, saw its ratio of total liabilities to earnings before interest, taxes, depreciation and amortization — or EBITDA — leap to 15.4% at the end of 2015 from 8.5% a year earlier.

The figure climbed to 28.6% from 14.9% at Greenland Holdings, 26.8% from 9.7% at Sunac China Holdings, and 58.5% from 20% at Shui On Land.

A study released in May by brokerage CLSA of China’s property, mining, manufacturing, utilities, construction, and wholesale and retail sectors counted potential problem debts of 14 trillion yuan ($2.14 trillion) as of the end of 2015.

The property sector represented over half the total, at 54.1%, with industries plagued by excess capacity, such as utilities, steel and coal, accounting for much of the rest. Notably, most of the recent corporate bond defaults have come from these loss-making sectors too, including state-owned power equipment manufacturer Baoding Tianwei Group and Dongbei Special Steel Group.

Worries about large-scale layoffs, especially in the steel and coal industries, have held the government back from pushing strongly on necessary capacity cutbacks. Instead, state banks have continued to extend more loans, said Francis Cheung, head of China-Hong Kong strategy at CLSA. Cheung estimates that the actual proportion of questionable debts on the books of China’s banks stands at 15-20%, compared with the 5.76% total reported by the central bank at the end of the first quarter for nonperforming loans and so-called special mention loans.

The combined effect of new international accounting rules and China’s banking regulations means that up to 10.6 trillion yuan in new capital will be needed to cushion the financial system, Cheung said.

“The biggest downside risk to investing in Chinese banks is their nonperforming loans that have yet to be fully reported,” said Ken Wong, client portfolio manager at Eastspring Investments, the fund management arm of UK insurer Prudential.