Shimao Group Holdings Ltd. was presumed to be one of the healthier developers in China’s market but is now yet another developer caught in the economic crossfire of Evergrande’s collapse and the subsequent cash crunch of the Chinese real estate sector.
Though Shimao’s financial health was previously marked as “green” by the Chinese real estate sector, it recently launched a fire sale after it defaulted on a $101 million domestic loan after the developer sold its entire stake in Shanghai Shimao Real Estate Development to a state-owned entity.
There are two important things to understand about Shimao’s financial fumbles. For one thing, while the risk of more property developers defaulting on their bond payments continues to rise, there are some hopes that some moves made by the Chinese government will avert a liquidity crisis in China’s real estate sector. Reuters had reported back in January that China will make it easier for state-backed property developers to buy up distressed assets of debt-laden private peers:
“State-owned developers acquiring distressed assets will not have those loans counted as debt under rules that cap borrowing. The “three red lines” policy restricts the amount of new borrowing property developers can raise each year by placing caps on their debt ratios.”
The second interesting point that Shimao highlighted is the effectiveness of the “three red lines” policy, which caps developers’ debt ratios by restricting their new borrowing each year. As stated earlier, Shimao had been deemed “green” by the Chinese market, and those three red lines were the very metric that determined Shimao’s viability. The three red lines measure developers by the following thresholds:
- The developer’s liabilities shouldn’t be more than 70% of assets
- The developer’s net debt shouldn’t exceed its equity.
- The developer’s cash must be at least equal to short-term borrowings.
The three red lines were unveiled less than a month before Evergrande’s collapse, but Chinese policymakers updated the guidelines at the beginning of this year. Now, the developer’s liabilities shouldn’t be more than 70 percent of assets, excluding debt accrued from acquiring distressed assets.
China’s government has recently shifted its focus to stabilizing growth, with the central bank easing monetary policy and the Chinese Communist Party ordering more fiscal spending early in 2022, but by doing so, it raises two questions. How far-reaching is the ripple effect from Evergrande’s debt crisis, and how trustworthy is the very metric it uses to determine developer health?