[Correspondent Column] Chinese Leadership Sets Out to Hunt the Gray Rhino

[Asia Economy Beijing=Special Correspondent Jo Young-shin] In December last year, Late Post, an online media operated by the Chinese economic specialist Caijing, reported an article titled "The Absurd Automobile Business of Evergrande Group." It stated that Evergrande, which ventured into the electric vehicle business, had purchased land totaling 11.33 million square meters (3.43 million pyeong) across China since September 2019 for electric vehicle factory sites. Among these, 52% were factory sites, and the rest were comprehensive sites where apartments, offices, and commercial buildings could be constructed. The expos? claimed that Evergrande's real interest was in the residential, office, and commercial developments attached to the factory sites.

[Image source=Yonhap News]

China had relaxed regulations to allow local governments to sell residential land to new energy vehicle companies as part of fostering new industries. Various benefits such as tax reductions were also granted when purchasing factory sites. Evergrande was criticized for exploiting these institutional loopholes. The National Development and Reform Commission (NDRC) of China immediately instructed local governments to "report detailed investment information on new energy vehicle manufacturing projects," explicitly mentioning "including Evergrande." At that time, within China, the NDRC's directive was interpreted as a move to expel Evergrande from the market.

On the 20th of last month (local time), when major indices on the New York Stock Exchange (NYSE) plunged sharply, some referred to it as the Chinese version of the "Lehman Brothers crisis." This statement arose from a lack of understanding of the causes of the Lehman crisis and the nature of Chinese real estate loans. First, China's loan-to-value ratio (LTV) for mortgages is between 50% and 70%. The LTV decreases depending on the real estate (house) held. Real estate loans in Chinese banks are also lower than feared. As of the end of June, the proportion of real estate corporate loans among 41 listed Chinese banks was 6.35%, and the non-performing loan ratio was 1.77%. Furthermore, the structure of loan products in China is very simple. Advanced financial techniques such as derivatives are not used in China. Unlike the Lehman crisis, it is impossible for dozens of creditors to appear for a single asset.

The loan loss provision ratios of Evergrande's major transaction banks are also not low. The loan loss provision ratio of Minsheng Bank, which has many loans to Evergrande, was 132.87% as of the end of last year. Agricultural Bank of China (274.53%), Industrial and Commercial Bank of China (191.97%), China Construction Bank (222.39%), Bank of Shanghai (324.04%), and Industrial Bank (256.94%) also have high loan loss provision ratios. This indicates some distance from banking sector insolvency risks.

Companies failing to meet debt management standards implemented by the People's Bank of China from January 1 ? including asset-liability ratio below 70%, net debt ratio below 100%, and cash ratio exceeding 100% against short-term debt ? are not as numerous as feared. Among the top 100 real estate companies in China, only 11 failed to meet these three conditions. Among them, Evergrande is the only company within the top 10. Thirty-five companies met all criteria, and 36 companies failed to meet one criterion.

That said, it does not mean there is no market shock from the Evergrande crisis. It is known that Evergrande has 8,441 subcontractors. As of the end of June, Evergrande's unpaid transaction payments amounted to 666.9 billion yuan. Most of these are reported to be current liabilities (debts to be repaid within 2 to 3 months).

If a mass bankruptcy of subcontractors occurs, public sentiment could become turbulent, and calls for accountability of the Chinese leadership may arise. Nevertheless, Chinese authorities have stopped financial support for Evergrande. This is interpreted as the Chinese leadership's determination to hunt the "gray rhino" (an easily overlooked risk factor). During the anticipated process of Evergrande's market exit, the corrupt realities of the Chinese real estate market are also expected to be exposed. The eradication of construction forces is likely to further consolidate the political power of the Chinese leadership, considering a third term. The Evergrande issue appears to be a series of processes aligned with political schedules.